Endogenous Structure of the Division of Labor, Endogenous Trade Policy Regime, and a Dual Structure in Economic Development

Xiaokai Yang

This paper develops a general equilibrium model with transaction costs and endogenous and exogenous comparative advantages. The governments are allowed to choose between tariff war, tariff negotiation, and a {\it laissez faire} regime. It shows that the level of the division of labor and trade increases as transaction conditions improve. When a high level of the division of labor occurs in general equilibrium, all countries prefer Nash tariff bargaining game that would result in multilateral free trade. If a medium level of the division of labor occurs in general equilibrium, then unilateral protection tariff in a less developed country and unilateral {\it laissez faire} policies in a developed country would coexist. The results show that tariff negotiations are 
essential for achieving multilateral free trade. In addition, the model may explain the policy transition of some European governments from mercantilism to free-trade regime in the 18th and 19th century and policy changes in developing countries from protection tariff to tariff negotiation and trade liberalization.