Cross-sectoral pollution externalities and multiple equilibria

HAL Id: hal-02469871

https://hal-amu.archives-ouvertes.fr/hal-02469871

Submitted on 6 Feb 2020

HAL

is a multi-disciplinary open access archive for the deposit and dissemination of sci- entific research documents, whether they are pub- lished or not. The documents may come from teaching and research institutions in France or abroad, or from public or private research centers.

L’archive ouverte pluridisciplinaire

destinée au dépôt et à la diffusion de documents scientifiques de niveau recherche, publiés ou non, émanant des établissements d’enseignement et de recherche français ou étrangers, des laboratoires publics ou privés.

Cross-sectoral pollution externalities and multiple equilibria

Larry Karp, Thierry Paul

To cite this version:

Larry Karp, Thierry Paul. Cross-sectoral pollution externalities and multiple equilibria. Environ- ment and Development Economics, Cambridge University Press (CUP), 2019, 24 (6), pp.624-642.

�10.1017/S1355770X19000147�. �hal-02469871�

Cross-sectoral pollution externalities and multiple equilibria

Larry Karp^1∗ and Thierry Paul²

1Department of Agricultural and Resource Economics, University of California, Berkeley, CA, USA and

2Aix Marseille University, CNRS, Marseille, France

*Corresponding author. E-mail: [email protected]

Keywords:coordination games; costs of adjustment; cross-sectoral pollution; factor reallocation; learning- by-doing; intersectoral migration; multiple equilibria

JELClassification: C61, J21,O13, R23

1. Introduction

Nonconvextechnologiescangiverisetomultiple competitive equilibria.Weextend intuitionaboutmultiplicityinmodelsofintersectorallabormigrationintwocircum- stances.First,productioninasectormightcreatepollutionthatlowersproductivityin theothersector.Second,cumulativeproductioninonesectormightlowercoststhere duetolearning-by-doingthatisexternaltofirms.Ourmaincontributionistoexplain whymultiplicity may be very unlikely in exactly the circumstances whereprevious modelswouldsuggestthatitislikelytooccur.

Insomecircumstances,thepayofffrommovingtoadifferentsector(‘migrating’)is higherifmanyotheragentsalsomigrate.Inthissituation,actionsarestrategiccomple- mentsandtheremaybemultipleequilibria.Forexample,inMatsuyama’s(1991)and Krugman’s(1991)migrationmodels,agentsdecidewhethertoworkintheAgricultural orManufacturingsector.Forsomerangeoflaborallocations,anexternalitycausesthe benefitofworkinginaparticularsectortoincreasewiththenumberofworkersthere.

Agents’decisionsdependontheirbeliefsaboutwhatotheragentswilldo,ratherthan merelyonexogenousorpredeterminedeconomicfundamentals.Thismodelhasbeen usedtoexplainwhysimilarcountriesmightfollowcompletelydifferentdevelopment paths.

Abstract:

In familiar models, a decrease in the friction facing mobile factors (e.g., lowering their adjustment costs) increases a coordination problem, leading to more circumstances where there are multiple equilibria. We show that a decrease in friction can decrease coordination problems when a production externality arises from a changing stock, e.g. of pollution or knowledge. In general, the relation between the amount of friction that mobile factors face and the likelihood of multiple equilibria is non-monotonic.

Ifitisverycostlyforagentstochangepreviousdecisions–i.e.,iftheamountoffric- tionisextreme–thenthereislittlescopeforagents’currentdecisionstodependon theirbeliefsaboutwhatotheragentswilldo.Inthiscase,the multiplicityofequilib- riaisunlikely.Ifthecostofchangingpreviousdecisionsisnegligible(andgiventhat actionsarestrategiccomplements),itisnaturaltothinkthatbeliefsareagreaterfactor inthedecision-makingprocess,makingthemultiplicityofequilibriamorelikely.This typeofreasoningleadstotheconjecturethatlowerfriction(cheapermigrationcosts) increasesthe ‘likelihood’ofmultiplicity.Weshowthatthisconjectureisnottruein general.

Ourmodelcanbeusedtodescribetwotypesofsituations.Thisflexibilityisimpor- tantbecauseitshowsthatourresultsarerelevantbeyondthecaseweemphasize,arising fromcross-sectoral pollutionexternalities.There,Manufacturingoutputcreatespol- lution flowsthatraisepollution stocks,damaging naturalcapitalandloweringlabor productivityinAgriculture,asinCopelandandTaylor(1999).Atapointintimethe wagedifferentialdependsonlyonthestockofnaturalcapital,whichisinverselyrelated tothepollutionstock.IncreasedManufacturingoutputincreasesthepollutionstock, loweringfuturelaborproductivityinAgriculture,alteringthefuturewagedifferential.

Byrelabellingvariables,themodelcanbeinterpretedasanextensionofKrugman’s (1991) migration model to includelearning-by-doing inManufacturing, as inMat- suyama(1992).Withthisinterpretation,laborproductivityinManufacturingdepends on theamountofknowledgeinthat sector.Manufacturingproductionincreasesthe stockofknowledge vialearning-by-doing;thisknowledge decaysifthe levelofpro- ductionfalls.Changesinthestockofknowledgealterthewagedifferential,changing incentivestomigrate.

Wedescribe ourresearchquestionandresults,andthenreviewrelatedliterature.

Theninsection2wepresentthemodelandinsection3theresults.

1.1 Research question and results

Dynamicmodelswithcomplementaritiescangiverisetotwoormorestablesteadystates.

Eachstablesteadystatehasabasinofattraction,definedasthesetofinitialconditions fromwhichthereisanequilibriumtrajectorythatapproachesthatsteadystate.Theinter- sectionoftwobasinsofattractionisthe‘RegionofMultiplicity’,orROM.IftheROMis empty,thereexistsauniqueequilibriumtrajectoryforallinitialconditions.Inthiscase, weregardtheequilibriumasunique,despitetheexistenceofmultiplesteadystates.In ourusage,‘equilibrium’alwaysreferstoatrajectory,notsimplytoasteadystate.Ifthe ROMhaspositivemeasure,thenthereexistsasetwithpositivemeasuresuchthatfrom anypointinthissettherearemultipleequilibriumtrajectories.Inthiscase,themodel exhibitsmultipleequilibriaforsomeinitialconditions.

Howdoesachangeinintersectorallabormigrationcostsaffectthe multiplicityof equilibria?Therearetwowaystointerpretthestatementthataparameterchangemakes multiplicity‘morelikely’:

Interpretation 1: The change increases the measure of the set of other parameters for which multiplicity occurs.

Interpretation 2: The change increases the measure of the ROM, holding fixed other parameters.

Interpretation 2 means that there are more initial conditions for which there exist multiple equilibria.

(a1)

(a2)

(b1)

(b2)

Figure 1.Phase space for different models. (a1) one-state, unique equilibrium; (a2) two-state, unique equilib- rium; (b1) one-state, multiple equilibria; (b2) two-state, multiple equilibria.

The model contains two state variables. The first of these is the fraction,L, of labor in Manufacturing. We denote the second state variable asK. In both interpretations of the model, a largerKincreases the Manufacturing-Agriculture wage differential, making it more attractive to work in the manufacturing sector. The mechanism behind this relation differs in the two interpretations of the model.

In the pollution setting, we interpretKas a pollution stock. An increase inLraises manufacturing output, increasing the flow of pollution generated in that sector, thereby increasing the pollution stock. The higher pollution stock lowers productivity in Agri- culture: the pollution externality is ‘cross-sectoral’ . In the learning-by-doing setting, we can interpretKas the stock or knowledge in Manufacturing. An increase inLagain raises manufacturing output, but now this higher output contributes to learning-by-doing, increasingK. The higher stock of knowledge raises Manufacturing productivity, increas- ing the Manufacturing-Agriculture wage differential. To avoid repetition, we focus on the cross-sectoral pollution interpretation.

Figure1illustrates the relation between the models with one and with two state vari- ables, and the distinction between the two interpretations of ‘more likely’. In the model with one state variable (L), illustrated by panels (a1) and (b1), the state space is [0, 1];

there are two steady states,L=0 andL=1 where, respectively, all labor is in Agricul- ture or in Manufacturing. In the model with two state variables,(L,K), illustrated by panels (a2) and (b2), the state space is the unit square. Here there are two stable steady states,(0, 0)and(1, 1). In the first, all labor is in Agriculture and the pollution stock is zero, so agricultural productivity is high. In the second, all labor is in Manufacturing and pollution is at its maximum level, equal to 1, causing agricultural productivity to be low.

In panels (a1) and (a2), the basins of attraction for the steady states, in both the one- state and the two-state models, are the setsAandB. These sets are intervals in the one- state model and regions in the two-state model. The setsAandBhave no intersection except for the boundary, which is of measure 0. A typical interior pointa∈A(orb∈B) has a unique trajectory to the steady state where all labor is in Agriculture (respectively, Manufacturing). Panels (a1) and (a2) illustrate the situation where the equilibrium is unique and there is hysteresis: the steady state depends on the initial condition.

In contrast, in panels (b1) and (b2) the state space consists of three sets,A,BandC.

The basin of attraction for the steady state with all labor in Agriculture isA∪C and the basin of attraction for the steady state with all labor in Manufacturing isB∪C. The intersection of these two sets,C, is the ROM. From pointc∈Cthere are two trajecto- ries, approaching different steady states. The equilibrium is not unique in the models

representedbypanels(b1)and(b2),becausethereisasetofinitialconditions,with positivemeasure,forwhichtherearemultipleequilibriumtrajectories.

AccordingtoInterpretation1,adecreaseinfrictionmakesmultiplicitymorelikelyif itincreasesthemeasureofthesetofparametersforwhichpanels(b1)or(b2)ratherthan panels(a1)or(a2)describesthedynamics.AccordingtoInterpretation2,thedecrease infrictionmakesmultiplicitymorelikelyifitincreasesthemeasureoftheROM,C.

Thechiefresultfromourtwo-dimensionalmodelisthatthereisanon-monotonic relationbetweenthemeasureoftheROMandfrictionintheadjustmentforlabor.Thus, accordingtoInterpretation2,adecreaseinlaboradjustmentcostsmaymakemultiplicity eithermoreorlesslikely.Adecreaseinlaboradjustmentcostsdoes,however,increase thesetofotherparametervaluesforwhichtheROMispositive.Thus,accordingtoInter- pretationI,loweradjustmentcostsmakemultiplicitymorelikely,justasinthestandard one-statemodels.ButaccordingtoInterpretation2,loweradjustmentcostsmightmake multiplicityeithermoreorlesslikely.Takentogether,thetworesultsimplythatiflabor adjustmentcostsareextremelysmall,the measureofthe ROMispositiveforawide rangeofparametervalues,butthemeasureisalwaysextremelysmall.Multiplicityin thiscaseispossible,butitoccursonlyforasmallsetofinitialconditionsandinthat senseisnotlikely.

For the type of model we consider, this non-monotonicity requires the second state variable,e.g. a stock pollutantinstead of a flow pollutant. However,the non- monotonicitysurvivesevenifthestockpollutantdecaysveryquickly.Inthatcase,the amountofdamage-creatingpollutionremainingoverasmallintervaloftimeclosely trackstheemissionsflowduringthatinterval–becauseemissionsflowsoverprevious periodshavealreadylargelydissipated.Inthisrespect,thetwo-statemodelwithrapidly decayingstockappearstoapproximateaone-statemodelwithaflowpollutant.Never- theless,thenon-monotonictydoesnotariseunderaflowpollutant.Thus,twomodels thatappearsimilarmightleadtodifferenttypesofresults.

Evenifthepollutionstockdecaysrapidly(causingthestocktocloselytrackthepol- lutionflow),itremainspossibleforthelabor allocationtochangestillmorequickly.

Rapidadjustmentoflaborrequiresthatmigrationcostsbesmall. Whenthe speedof adjustmentinthelabormarketisfastrelativetothespeedofadjustmentofthepollution stock,aworkercanmovebetweensectorsquicklyenoughtoinsurethatsheremains inthehighwagesector‘mostofthetime’.Inthiscase,formostinitialconditions,the worker’smigrationdecisionisnotsensitivetoherbeliefsaboutwhatotherworkerswill do.Multiplicityispossible,buttheROMissmall.

Weuseadeterministicmodelandassumethatagentshaverationalpointexpecta- tions:theycorrectlyanticipatetheevolutionoftheeconomy. Ifagentsweremyopic, therewouldbenoroleforexpectationstoinfluencebehavior.Theremightnevertheless bemultiplestablesteadystates,eachwithitsbasinofattraction.Inthiscase,therewould behysteresis,butnotmultiplicityofequilibria(asweusethatterm).

1.2 Literature review

Previousliterature,exceptingKrugman(1991),FukaoandBenabou(1993)andKarp andPaul(2007),neglectstherelationbetweenparametersofthemodelandthemea- sureoftheROM,andconcentratesontherelationbetweenparametervaluesandthe existenceofaROMwithpositivemeasure.Therearetwolikelyreasonsforthisempha- sis.First,althoughitissometimesstraightforwardtodetermineconditionsunderwhich theROMhaspositivemeasure,thecomparativestaticsofthismeasurearecomplicated.

Second,intuition(supportedbyKrugman’smodel)mayhaveencouragedtheideathat thetwo sensesinwhicha parameterchange canmakemultiplicity ‘more likely’are essentiallythesame.

Multiplicityofequilibriaariseswhenthereareincreasingreturnstoscale,orsome otherfeaturethat makesthe economynon-convex.Greaterconvexityofadjustment costs (more generally, increased friction) appears to counteractthe effect of cross- sectoralpollutionorincreasingreturnstoscale.Therefore,anaturalconjectureisthat moreconvexadjustmentcostsmakemultiplicitylesslikely.KarpandPaul(2007) use numericalmethodstoshowthatthisconjectureisnottrueingeneralinatwo-statever- sionofKrugman(1991).Hereweuseasimplerframeworkandobtainanalyticresults, therebyimprovingourintuitionforthistypeofmodel.

Thereis little empirical evidence regardingthe typeof multiplicity we described above.Davis and Weinstein (2002, 2004) find that Japanese datais consistent with increasingreturnstoscale,butthatthedataisinconsistentwiththeexistenceofmul- tiplestablesteady states–anecessary conditionformultiplicity ofequilibriainthis setting.Moro(2003)estimatesamultipleequilibriummodelofwageinequality;Brock andDurlauf(2001,2002)discusstheestimationofdiscretechoicemodelswithsocial interactions,asituationthatcanleadtomultipleequilibria.

Thereisa differenttypeofmultiplicity,often referredtoas‘indeterminacy’, that occurswhenthereexistsacontinuumofequilibriumtrajectoriestoasinglesteadystate.

Indeterminacyisan importanttopicinmacro-economics,wheretheroleofcostsof adjustment(friction)issignificant.BenhabibandFarmer(1999)reviewthisliterature;

recentcontributionsincludeCooperandHaltiwanger(1996),CooperandJohri(1997), Wen(1998a,b),Benhabibetal.(2000),NishimuraandShimonura(2002)andLubikand Schorfheide(2004).Arecurringquestionconcernsthespecificationforwhichplausible estimatesofadjustmentcostsandreturnstoscaleareconsistentwithindeterminacy.In thesemodels,lowercostsofadjustment(lessfrictionforthemobilefactor)meanthat indeterminacyismorelikely,usingInterpretation1.Sincetheanalysisofthesemodels (typically)examinesbehaviorintheneighborhoodofthesteadystate,noattentionis paidtoInterpretation2.

Recenttheoretical papersshowthatchanginganassumption ofmigrationmodels mayeliminatethemultiplicityofequilibria.FrankelandPauzner(2000)showthatmul- tiplicitydisappearsinavariationofMatsuyama’smodelwherethewagedifferentialis subjecttoBrownianmotionandthereexist‘dominanceregions’.Inanothervariationof thismodel,Herrendorfet al. (2000)showthatthereisauniqueequilibriumifagentsare sufficientlyheterogeneous.Weprovideanotherexplanationthatmighteitherincrease ordiminishtheimportanceofcoordinationproblems.

2. Themodel

Thediscretetimemodelmakesiteasytoobtainthecomparativestaticresultsinsection3.

Tointroduceourmodelandalsotoestablishtheconnectionbetweenourdiscretetime formulationandpreviousliterature, webegin with aone-state, two-periodformula- tion(section2.1).ThismodelreproducesthemajorinsightsfromKrugman(1991) who considersincreasingreturnstoscalethatareexternaltofirms,whereaswefocusoncross- sectoralpollution,whereboth sectorshaveconstant returnstoscale.Thisdifference changestheinterpretationoftheone-statemodelbutnotthenatureoftheresults.

Ourcontribution usesatwo-state, three-periodmodelwhereallmigrationoccurs duringthefirsttwoperiods(section2.2).Weusethetwo-state,three-periodmodelin

section3toshowanalyticallythatanincreaseinintersectorallabormobility(adecrease infriction)canreducethesetofinitialconditionsfromwhichthereemanatemultiple equilibriumtrajectories.Thatis,anincreaseinmobilitycandecreasethemeasureofthe ROM,andinthisrespectmakemultiplicitylesslikely.

2.1 The two-period, one-state model

ThissectionobtainstheinsightsfromKrugman’scontinuoustimeformulationusing atwo-periodmodel.TheinitialstockoflaborinManufacturingis0 ≤ L ≤ 1andthe measureofentrantsintoManufacturingisu,sotheamountoflaborinManufacturing inthenextperiodisL + u.Workerswhomoveincuracostofmigrationinthecurrent periodand(possibly)obtainahigherwageinthenext.Thediscountfactoris β.The manufacturingwageisfixedat αM.Pollutionarisingfromthemanufacturingsectorin thesecondperiodequalsL + u.Averageandmarginalproductivity(andthusthewage) inAgricultureinthisperiodequalsαA − b(L + u);eachunitofpollutionlowersthe wageinAgriculturebybunits.Thisone-statevariablemodeldescribesaflowpollutant.

TheManufacturing-Agriculturewagedifferentialinthesecondperiodthereforeequals a + b(L + u), witha ≡ αM − αA.Weassumethata < 0anda + b > 0:ifallworkers areinthesamesector,thatisthehigh-wagesector.

Thesocialcostofmigrationisu²/2γ , with γ >0.Migrationservicesarecompet- itivelysupplied,sothepriceofmigration(theamountthatamigrantpaysinorderto switchsectors)is |u|/γ .Ahighervalueof γ meansthatadjustmentcostsarelower:there islessfriction.Anagentwhodecidestomigratepaysthemigrationcostinthecurrent period,inordertobeinadifferentsectoratthenextperiod.

ThepresentvalueofthebenefitminusthecostofmigratingtoManufacture(u > 0) ortoAgriculture(u < 0)equalsthepresentvalueofthewagedifferentialminusthecost ofmigration:

n(L,u)≡ 1

γ(βγ (a+b(L+u))−u). (1)

Forbγβ <1, the net benefit of migration decreases with the number of other agents migrating. In this case, actions are strategic substitutes and the equilibrium is unique.

Agents play a coordination game (i.e. actions are strategic complements), and there are multiple equilibria, if and only ifbγβ >1, as we hereafter assume.

Figure2graphs the migration constraints 0≤L+u≤1 (the dotted lines) and the solution ton=0 forbγβ >1 (the solid line). TheLcoordinates of the points of intersec- tion between the graph ofn=0 and the migration constraints (the heavy dots in figure2) define the interval [1−(a+b)βγ,−βaγ]. This interval corresponds to the intervalC in figure1, panel (b1). The ROM consists of the intersection of this interval and the set of feasible initial conditions, [0, 1]. For an initial condition (a value ofL) in the ROM, the value ofuthat satisfiesn(L,u)=0 (i.e., a point on the solid line) is an unstable equi- librium.¹At initial conditions inside the ROM there are two stable equilibria: all labor moves to Manufacturing or to Agriculture. For example, atu=1−LforL∈ROM, the benefit of moving to Manufacturing exceeds the cost (n(L, 1−L) >0) so it is a stable

1We use the standard notion of stability. At an interior equilibrium,n=0 anddn/du>0. If a small measure of agents ‘deviate’ (e.g., they migrate to Manufacturing when their equilibrium action is to remain in Agriculture), then other agents would want to follow the deviation. The interior equilibrium is therefore unstable.

Figure 2.The ROM in a one-period model withβγG>1. The heavy dots, given by theLcoordinates of the solid and the dotted lines, show the boundary of the ROM.

equilibrium for all labor to move to Manufacturing. The length of theROMis

Length of ROM =max{0, min{1,−βaγ})−max{0, 1−(a+b)βγ}}. (2) ForinitialconditionstotheleftoftheROM,theuniqueequilibriumsendsalllaborto Agriculture.ForinitialconditionstotherightoftheROM,theuniqueequilibriumsends alllabortoManufacturing.

Theexistenceofmultiplicityrequiresacombinationofpatience,alargeexternality, andlowadjustmentcosts(largevaluesof β,b, γ ),justasinKrugman(1991).Anincrease inanyofthesefactorsincreasesthelengthoftheROMwhenthisispositiveandlessthan 1.Thus,loweradjustmentcostmakesmultiplicity‘morelikely’inbothsensesdescribed intheIntroduction.

Forthismodelwedonotneedanyassumptionsaboutthemeasureusedtoassessthe likelihoodofmultiplicity;thatis,thestatementthatmultiplicitybecomesmorelikely isindependentofthepriorsontheinitialconditionandonband β.Forexample,an increasein γ cancauseinitialconditionstoentertheROMbutnevercauseinitialcon- ditionstoleavetheROM.Here,thereisnolossingeneralityinusingthelengthofthe ROMtomeasurethelikelihoodofmultiplicity.Thismeasurecorrespondstoauniform prioroverinitialconditions.

2.2 The three-period, two-state model

Thissectionintroducesthemodelthatweusetoestablishthenon-monotonicityofthe ROMwithrespecttolaboradjustmentcosts.Currentmigrationaffectsthelaborallo- cationinthenextperiod,andcurrentpollutionaffectsthepollutionstockinthenext period.Theperiodindexist∈ {0,1,2}.Thepredeterminedstockofpollutioninperiod tequalsK_t andtheflowofpollutioninperiodtisGL_t , with G > 0.Eachunitoflabor inManufacturinginthecurrentperiodaddsGunitstothenext-periodpollutionstock.

Thestockofpollutionint + 1 is

K_t+1=K_t+G(L_t−K_t)⇒K_t+1−K_t =G(L_t−K_t). (3) Each unit ofthis stock reducesproductivity in Agricultureby b units. The pollution stock attispredetermined,sotheAgriculturewageattis αA − bK_t.TheManufacturingwage

is fixed atαM, so the Manufacturing-Agriculture wage differential isαA−αM−bK_t = a−bKt.

In order to focus on our research question, we hereafter seta=0.5 andb=1, so the wage differential is 0.5−K_t. With this choice of parameters, the wage differential equals 0 atK=0.5. Using equation (3), the pollution stock is constant atK=0.5 only forL= 0.5. Thus,K=L=0.5 is the only interior steady state for this linear model. Just as in the one-state model, this interior equilibrium is unstable. To further simplify notation, we define the state variables as deviations from these values:lt ≡Lt−0.5 andkt≡Kt−0.5.

By construction,k_tequals the Manufacturing-Agricultural wage differential in periodt.

The state space for the model is the square

−0.5≤lt ≤0.5,−0.5≤kt ≤0.5, (4) and the equation of motion for the transformed pollution stock is

k_t+1=kt+G(lt−kt). (5) Migration decisions are made att=0 and att=1. Agents base their migration deci- sions on their beliefs about wages in periodst=1 andt=2 and on migration costs in periodst=0 andt=1. Denote the amount of migration to Manufacturing in period 0 asu(as in the one-period model) and the amount of migration to Manufacturing in period 1 asv. Negative values mean that migration is into Agriculture. The social cost of migration is quadratic in migration, and the price that a migrant pays is|u|/γ in period 0 and|v|/γ in period 1. In the initial period, (t=0), the state variablesL₀,K₀ are given.

We adopt the following parameter restriction:

0<G≤1. (6)

Thisrestrictionandequation(3)implythatthenext-periodpollutionstockisaconvex combinationofthe currentpollutionstockandthecurrent flow.Becauseourobjec- tiveistodemonstrateandexplainacounter-intuitiveresult,itissufficienttoshowthat theresultholdsforreasonable–notforall–parameterizations.² Section3.2notesthat inequality(6)hasaphysicalinterpretation.Ifwethinkofthediscretetimemodelasan approximationtoacontinuoustimemodel,thevalueG = 1correspondstothefastest possiblespeedofadjustmentofthepollutionstock.ThespecialcaseG = 1alsoleadsto particularlysharpanalyticresults.

3. Results

Wefirststateourprincipalresult.Thenextsectioncontraststhecomparativestaticsof theROM,withrespectto γ ,intheone-stateandthetwo-statemodels.Afinalsection offersadifferentperspective,sketchingacontinuoustimemodel.

Our principal results use the following definitions:

X(k₀)= −φ

χk₀−0.5γβ²G−1 χ

2If we did not impose the upper limit in equation (6), our proof of Proposition 1 would require distin- guishing between the two cases whereG≷1+√

γβ+1/γβ. The restrictionG≤1 means that we need consider only one of these two cases.

Y(k₀)= −φ

χk₀+0.5γβ²G−1

χ , (7)

where

χ=γβG(γGβ+3+β−βG−G)+1

φ =γβ(γβG+2.0−1.0γβG²−3.0G+G²−2.0βG+β+βG²).

The following Proposition summarizes our main results; the appendix contains the proof.

Proposition 1. Suppose that inequality (6) holds in our three-period model.

(i) β²Gγ >1is necessary and sufficient for the ROM to have positive measure. Thus, an increase inγ (i.e., a decrease in friction) increases the range of other parameter values (βand G) for which the ROM has positive measure.

(ii) The ROM is defined by the following set:

ROM= {(k,l):−.5≤k≤.5∩ −.5≤l≤.5∩Y(k)≤l≤X(k)}. (iii) Forβ²Gγ >1, the area of the ROM is non-monotonic inγ.

The condition for the ROM to have positive measure,β²Gγ >1, is essentially the same as for the one-state variable model (withGplaying a role analogous tob) except that here the condition involvesβ²rather thanβ. This difference arises because in the two-state variable model migration in periodt affects the wage differential in period t+2 rather than in periodt+1 (as was the case in the two-period model). The lag occurs because here the pollution stock mediates the effect of a change in labor allocation. In the one-state variable model, which describes a flow pollutant, the change in labor allocation has an immediate effect on the wage differential.

Figure3shows an example of the ROM. (Compare to figure1, panel (b2).) The lower line is the graph ofXand the upper line is the graph ofY, defined in equation (7). The area between these two lines is the ROM. Restriction (6) andβ²Gγ >1 imply thatχ >0.

This fact, equation (7), and the assumption thatγβ²G>1 imply thatX<Y. For any k0, the vertical distance betweenYandXis

M≡Y−X= γβ²G−1

χ >0. (8)

In general, we do not have a simple closed form expression for the area of the ROM.

However, ifY(0.5) <−0.5 orX(0.5) >−0.5, then the ROM does not include the NW or SE corners of state space, and the ROM is a parallelogram. IfX(0.5) >−0.5, the area of the ROM is simplyM.³

3IfY(0.5) <−0.5, the measure of the ROM is the horizontal rather than the vertical distance between the linesXandY.If the ROM includes the corner of state space (i.e., ifX(0.5) <−0.5<Y(0.5)), then in computing its area we need to account for the ‘missing triangles’ at the corners, and the formula for the measure becomes more complicated. It is easy to confirm that any of these three configurations are possible, depending on parameter values.

Figure3.The ROM (areabetweenlines)for β = 0.8, G = 0.5, γ = 2.5.

Interpretation2statesthataparameterchangeincreasesthemeasureoftheROM.

Ingeneral,checkingthisconditionrequiresthatwedefinethe‘measure’,i.e.aproba- bilitydistributionforthesetofinitialconditions.Forexample,iftheinitialconditions areuniformlydistributedovertheunitsquare(thestatespace),thenanincreaseinthe area oftheROM unambiguouslyraisesthelikelihood thatan arbitrarilychosenini- tialconditionliesintheROM.However,foranon-uniformdistribution,anincrease intheareaoftheROMdoesnot,ingeneral,implythatitis‘morelikely’thatanini- tialconditionliesintheROM.Forgeneralparametervalues,achangein γ causesthe ROMtorotateasitsareachanges.Therefore,fortwovaluesof γ , γ1 = γ2 theinequality area(ROM(γ1)) > area(ROM(γ2) doesnotimplythatROM(γ2) ⊂ ROM(γ1).Conse- quently,unless the distributionofinitial conditions isuniform overstatespace, the factthatarea(ROM(γ1)) > area(ROM(γ2) doesnotnecessarilymeanthatmultiplicity ismorelikelyunder γ1 thanunder γ2.

Incontrast,forthespecialcaseG = 1,equation(5)impliesthatthewagedifferential inthenextperioddoesnotdependonthecurrentwagedifferential(thecurrentvalue ofk).WhenG = 1theROMisflat;itsboundariesareindependentofk₀. For G = 1,the magnitudeof γ affectsonlytheverticaldistancebetweenthetwolinesinfigure3.Inthis case,area(ROM(γ1)) > area(ROM(γ2) doesimplythatRom(γ2) ⊂ Rom(γ1).Thus,for G = 1,alargerareaoftheROMmeansthatmultiplicityis‘morelikely’,regardlessofthe distributionoftheinitialcondition.

3.1 Comparison of one-state and two-state models

Wenotedthatthepresenceofasecondstatevariable(thestockofpollution)changesthe relationbetweentheamountoffrictioninlaboradjustmentandthelikelihoodofmulti- plicityofequilibria,ascapturedbythemeasureoftheROM.Therearetworeasonswhy thecaseG = 1isparticularlyusefulforillustratingthisdifference.First,asnotedabove, inthissituationthereisnolossingeneralityinusingauniformpriorforinitialcondi- tions.Second,thecaseG = 1isofspecialinterestbecauseitleadstoamodelthatappears toapproximatetheone-statevariablemodel.RecallthatG = 1correspondstocomplete adjustmentofthepollutionstock,followingchangesinL,withinasingleperiod.That is,whenG = 1thestockofpollutionadjustsveryrapidly–preciselythesituationwhere wemightexpectthataone-dimensionalmodelprovidesagoodapproximationtothe two-dimensionalmodel.

Figure 4.ForG=1, measure of ROM is 0 below the dotted curve, increasing inγbetween curves, and decreasing inγabove solid curve.

WhenG=1 the area of the ROM is max{0,M}, withM=γβ²−1/γ²β²−1. Thus, γ > β⁻²is necessary and sufficient for the ROM to have positive measure whenG= 1. Forβ=1,M=1/γ +1, which is strictlydecreasing inγ. For β <1,M is first increasing inγ (in the neighborhoodβ⁻²) and then decreasing. The measure reaches its maximum atγ^m≡1/2β²(2+2

1−β²)and thereafter decreases. The maximum pointγ^mconverges toβ⁻²asβ →1.

Figure4shows the graph ofγ^m(the solid curve) and ofβ⁻²(the dotted curve). For combinationsof (β, γ )belowthedottedcurve,themeasureoftheROMis0;forapoint betweenthetwocurves,themeasureoftheROMisincreasingin γ ,holding β fixed;and forpointsabovethesolidcurve,themeasureisdecreasingin γ ,holding β fixed.

Inpresentingthemodelwithtwostatevariables,wesetb = 1anda = −0.5.There- fore,tocomparethetwomodelsweneedtousethesevaluesinthemodelwithonestate variable.Herewealsosetβ = 1,sothatthe necessaryandsufficientconditionfora positivemeasureoftheROMis γ >1inbothmodels.Withtheserestrictions,figure5 graphsthemeasureoftheROMinthetwomodels,for γ >1.Thisfigureusesequations (2)and(8).Thefigureshowsthatthefrictionparameter γ hastheoppositeeffectonthe measureoftheROMinthetwomodels.

3.2 A different perspective

Herewesketchacontinuoustimemodeltomakethreepoints.First,itprovidesaphysical interpretationofrestriction(6).Second,itshowsthatourdiscretetimemodelcanbe viewedasanapproximationofacontinuoustimemodel.Third,theideaoftwostate variablesadjustingatdifferentspeedsistransparentinthecontinuoustimesetting,but notinthediscretetimesetting.Theonlineappendixdescribesamoregeneralmodel.

The continuous time analog of equation (3) is

K˙ =g(L_t−K_t). (9)

If weholdL_t inequation(9) constantfor oneunitoftimeand solvethatequation, torewriteit inthe same formas equation(3), weseethat the relationbetweenthe

Figure 5.Meausure of ROM, withβ=G=b=1. The solid curve shows that for the model with one state vari- able, the measure increases withγ. The dotted curve shows that for the model with two state variables, the measure decreases withγ.

two parameters isG=1−e^−g. Becauseg≤ ∞, the restrictionG≤1 is reasonable. Of courseG>0 because the pollution flow affects the stock.

Define a ‘provisional’ steady state of pollution as the steady state corresponding to a fixed value of labor allocation. For example, consider two economies. The first has been largely rural, with only 5 per cent of its labor force in Manufacturing (L=0.05), and the second has been industrialized, with 95 per cent of labor in the Manufactur- ing sector (L=0.95). If the two economies have been at their respective stages for a long period of time, then in both economies the respective pollution stocks will be close to their ‘provisional’ steady states:K=0.05 for the first economy andK=0.95 for the second. These are the values ofKthat solveK˙ =0 in equation (9). The rela- tively low level of manufacturing in the first economy corresponds to a relatively cleaner environment.

In the continuous time setting, adjustment to a provisional steady state can be made arbitrarily rapid, by increasing the speed of adjustment parameterg in equation (9).

Asg→ ∞, the pollution stock adjusts instantaneously. For largeg, the pollution stock never deviates far from the pollution flow. Therefore, for largega flow pollutant model approximates a stock pollutant pollutant model. In contrast, in the discrete time setting with our timing convention, adjustment of pollution to a provisional steady state takes at least one period, i.e. it always occurs with a lag. The two-state discrete time model cannot exactly reproduce the one-state model.

Defineuas the flow of labor into Manufacturing (foru>0) or into Agriculture (for u<0), sodL/dt=u. The flow cost of migration isu²_t/2γ, so a migrant at timetpays the migration cost|ut|/γ. As in Krugman’s one-state model,γ is inversely related to friction;γ is a speed-of-adjustment parameter for labor. Whengandγ differ by orders of magnitude, the time scales over which the two state variables change are different:

there are ‘slow-fast dynamics’. Equation (9) can be rewritten as K˙

g =L_t−K_t. (10)

In the limit, asg→ ∞, equation (10) implies thatK_t=L_t, which implies that the Manufacturing-Agricultural wage differential in periodtisLt−0.5. This formula for the wage differential is the same as in Krugman’s setting, usinga= −0.5 andb=1.

(We adopt these two parameter restrictions only to simplify the exposition.) More gen- erally, whengis large (for fixedγ),Kadjusts rapidly, relative to the speed of adjustment ofL. Here, the pollution stock closely tracksL:K≈Lforglarge.

Thus, it would appear that the one-state model should provide a good approxima- tion to the two-state model when the pollution stock adjusts rapidly. However, the two models have different implications concerning Interpretation2. Provided thatg<∞, by makingγ large migration becomes cheap enough that a worker can be sure of being in the high wage sector ‘most of the time’, regardless of other workers’ decisions. In this case, a worker bases her migration decision primarily on the state variables, not on her beliefs about what other workers will do. Multiplicity is still possible, but it occurs for a small set of initial conditions: it is unlikely.

When gis finite, current migration affects the second time-derivative of the wage differential,

d²(K−0.5)

dt² =g(u−g(L−K)).

Incontrast, in Krugman’s model (g= ∞), current migration affects the first time- derivativeofthewagedifferential.Thepresenceofthesecondstatevariablemediates migration’seffectonthewagedifferential.Inadiscretetimesetting,wesawthatthe presenceofthesecondstatevariablecausesmigrationtoaffectthewagedifferentialwith a lag.

4. Conclusionanddiscussion

Manydynamicmodelscanbeviewedasextensionsofstaticmodels,obtainedbyintro- ducingapayoff-relevantstatevariablethatadjustsovertime.Thereareusuallymany waysofmaking amodeldynamic. Ifwe thinkthat thefrictioninthe adjustmentof the mobilefactor isthe single most importantsource ofdynamics,it is essentialto includethelaborallocationasastatevariable.Theadditionalcomplexitythatcomes fromincludingasecondstatevariableisapowerfulargumentinfavoroftheone-state model.

Inaddition,wemaythinkthattheone-statemodelisadequate.Forexample,wemight agreethatthecross-sectoralexternalityisnotliterallyassociatedwiththepollutionflow, andthatinsteaditisassociatedwithapollutionstock.However,ifthepollutionstock trackstheflowveryclosely,itmightappearthattherewouldbelittlelossofeconomic insightinreplacingthepollutionstockwiththeflow,therebyusingaone-statemodel.

Inastandardoptimalcontrolsetting(i.e.,agameagainstnature),whenthespeedof adjustmentofdifferentstatevariablesdiffersbyordersofmagnitude,ahigherdimen- sionalproblemcanoftenbewell-approximatedusingalowerdimensionalstatespace.

Wheretechnologyisconvex,acompetitiveequilibriumcanbeobtainedbysolvinga planner’soptimizationproblem.

However,innonconvexsettings,anequilibriumprobleminvolvingagentswithratio- nalexpectationscangiverisetomultipleequilibria.Inthissituation,itistypicallynot possibletoobtaintheequilibriumbysolvingaplanner’sproblem.Here,anapparently innocuousreduced-dimensional‘approximation’ofa higherdimensionalstatespace

might change important features of the problem. We used a simple model with two state variables to illustrate and explain this possibility.

When we ask how an increase in labor adjustment costs affects the likelihood of multi- plicity, we might have in mind two different relations. Friction affects the measure of the set of (other) parameter values under which multiplicity is a possibility, and it affects the measure of the set of initial conditions for which multiplicity actually occurs. In Krug- man’s model and in our two-period simplification, the answer to the comparative statics question is the same, regardless of which of these two interpretations we have in mind.

The theoretical and empirical literature on indeterminacy emphasizes the first inter- pretation. There is little discussion in the literature involving the second interpretation, which is arguably as important as the first.

We showed that when the labor allocation affects the wage differential with a lag, either because of an environmental stock externality or due to a stock of knowledge aris- ing from learning-by-doing, then the answer to the comparative statics question may differ, depending on which interpretation one adopts. Under the first interpretation, a decrease in friction always makes multiplicity more likely in our model, just as in the one- state setting. Under the second interpretation, the relation is non-monotonic, unlike in the one-state setting.

When it is harder for an agent to take an action, such as moving to a new sector, it seems that there would be fewer initial conditions under which her decision would depend on beliefs about what other agents will do. This conclusion is (by now) so well-established that it seems obvious. However, when the current wage differential is sluggish, as occurs in our two-state model, the relation is reversed for low cost of labor adjustment. With low adjustment costs, for most initial states the agent’s equilibrium migration decision does not depend on beliefs about what others will do; whatever their actions, it is cheap for an agent to move in future periods in order to remain in the high wage sector. That is, for most initial conditions, agents have a dominant strategy when adjustment costs are low.

This theoretical point shows the danger of drawing conclusions about the importance of multiplicity based on estimates of structural parameters of the model (i.e., based on Interpretation1). Parameter estimates might suggest, for example, that there are signif- icant cross-sectoral negative externalities or within-sectoral increasing returns to scale (or some other source of non-convexity); that factor adjustment costs are very low; and that a one-state variable model apparently provides a good approximation to the econ- omy (because other state variables adjust rapidly). The conventional wisdom is that in these circumstances the ROM is likely to have positive measure. Our results agree with this conclusion, but also suggest that the measure of the ROM is likely to be very small, and therefore the economy is unlikely to have multiple equilibria.

An economy that has multiple steady states but a unique equilibrium might evolve in very different ways, depending on the initial condition. For example, an exogenous change in pollution control technology or environmental policy can change incentives about where to invest. Those kinds of exogenous changes can alter an interior steady state, leading to standard comparative statics results. If the changes in pollution control or policy are small, we expect the change in the steady state to also be small. How- ever, those exogenous changes might shift the basins of attraction. If the shift causes a predetermined state variable to now reside in a different basin of attraction, the small exogenous change can cause the system to approach a different steady state. In that case, the exogenous change causes a large change in the equilibrium trajectory, even though each of the steady states has changed by a small amount.

Mattersareevenmorecomplicatediftherearemultiplesteadystatesandalsomulti- pleequilibria,i.e.iftheROMhaspositivemeasure.Here,wheretheoutcomedependson agents’beliefsaswellaseconomicfundamentals,thestandardapplicationofcompara- tivestaticsmighttellusverylittle.Wewouldhavetoknowhowtheexogenouschange altersagents’beliefs.

Supplementarymaterial. The supplementary material for this article can be found at https://doi.org/10.

1017/S1355770X19000147.

Acknowledgements. We thank Tasos Xepapadeas and two anonymous referees for comments on an earlier draft. The usual disclaimer applies.

References

Benhabib J and Farmer R (1999) Indeterminacy and sunspots in macroeconomics. In Taylor JB and Woodford M (eds), Handbook of Macroeconomics, vol. 1, part A, Amsterdam: North Holland, pp.

387–448.

Benhabib J, Meng Q and Nishimura K (2000) Indeterminacy under constant returns to scale in multisector economies. Econometrica 68, 1541–1548.

BrockWandDurlaufS(2001) Discrete choice with social interactions. Review of Economic Studies 68, 235–260.

BrockWandDurlaufS(2002) Market implications of peer and neighborhood effects. American Economic Review 92, 298–309.

CooperRandHaltiwangerJ(1996) Evidence on macroeconomic complementarities. Review of Economics and Statistics 78, 78–93.

CooperRandJohriA(1997) Dynamic complementarities. Journal of Monetary Economics 40, 97–119.

Copeland B and Taylor M (1999) Trade, spatial separation, and the environment. Journal of International Economics 47, 137–168.

Davis D and Weinstein DE (2002) Bones, bombs and break points: the geography of economic activity.

American Economic Review 92, 1269–1289.

Davis D and Weinstein DE (2004) A search for multiple equilibria in urban industrial structure. NBER Working Papers 10252, National Bureau of Economic Research, Inc.

Frankel D and Pauzner A (2000) Resolving indeterminacy in dynamic settings: the role of shocks. Quarterly Journal of Economics CXV, 285–305.

Fukao K and Benabou R (1993) History versus expectations: a comment. Quarterly Journal of Economics 108, 535–542.

Herrendorf B, Valentinyi A and Waldman R (2000) Ruling out multiplicity and indeterminancy: the role of heterogeneity. Review of Economic Studies 67, 295–307.

Karp L and Paul T (2007) Indeterminacy with environmental and labor dynamics. Structural Change and Economic Dynamics 18, 100–119.

KrugmanP(1991) History versus expectations. Quarterly Journal of Economics 106, 651–667.

LubikTAandSchorfheideR(2004) Testing for indeterminacy: an application to U.S. monetary policy.

American Economic Review 94, 190–217.

MatsuyamaK(1991) Increasing returns, industrialization, and indeterminancy of equilibrium. Quarterly Journal of Economics 106, 587–597.

Matsuyama K (1992) Agricultural productivity, comparative advantage, and economic growth. Journal of Economic Theory 58, 317–334.

Moro A (2003) The effect of statistical discrimination on Black-White wage inequality: estimating a model with multiple equilibria. International Economic Review 44, 467–500.

Nishimura K and Shimonura K (2002) Indeterminacy in a dynamic small open economy. Journal of Economic Dynamics and Control 27, 271–281.

Wen Y (1998a) Capacity utilization under increasing returns to scale. Journal of Economic Theory 81, 7–36.

Wen Y (1998b) Indeterminacy, dynamic adjustment costs and cycles. Economics Letters 59, 213–216.

AppendixA:ProofofProposition1

Weconstructtheequilibriumbyworkingbackwards,beginningwiththeagents’problem in period 1, the last period during which they can migrate.

Using equation (5) and l₁ = l₀ + u, we write the present value at t = 1 of being in Manufacturing in period 2, as

βk₂ = β(k1 + G(l₁ − k₁)) = β(G(2 − G)l₀ + (G − 1)²k₀ + Gu) ≡ f (u;k₀,l₀).

Our timing conventions imply that this value is predetermined at period 1. The equilib- rium for the subgame beginning in period 1 is therefore unique. Agents are indifferent between migrating and staying in their current sector if and only if βk₂ = v/γ , i.e. if v = γ f (u; l0, k0). The speed of adjustment parameter affects the magnitude but not the sign ofthequantity γ f (·), andf (·) isincreasinginu forallG > 0.

Taking into account the labor supply constraint, the equilibrium value ofvis v(u)=

⎧⎨

⎩

0.5−l0−u if γf >0.5−l0−u γf if −0.5−l₀−u≤γf ≤0.5−l₀−u

−0.5−l0−u if γf <−0.5−l0−u

⎫⎬

⎭. (A1) FigureA6shows an example of the graph ofv(u), given particular valuesl₀=0 andk₀>0.

Theucoordinate of the left and the right kink in this graph are, respectively left kink: p≡ρ(l0,k₀)− 0.5

1+γβG right kink: q≡ρ(l0,k₀)+ 0.5

1+γβG, using the definition

ρ(l0,e₀)≡ 1

1+γβG(γβG(G−2)−1)l0−γβ(G−1)²k₀).

For alll0 and k0, it is always the case thatp<q. Inequality (6) implies that ρ is a decreasing function ofl₀, sopandqare decreasing functions ofl₀– a fact that we use below.

Using these definitions and equation (A1) implies dv(u)

du =

⎧⎨

⎩

−1 if u>q βGγ if p<u<q

−1 if u<p

⎫⎬

⎭. (A2) Thus, an increase inuincreases the equilibriumv, provided thatvis interior. In contrast, an increase inudecreases the equilibriumvwhen this variable is on the boundary of the labor supply constraint, as figureA6illustrates.

In period 1 an agent is either indifferent between migrating and staying in her current sector (at an interior equilibrium) or she strictly prefers to migrate (at a boundary equilib- rium). Agents with rational expectations understand this fact in period 0. Therefore, the benefit of migrating to Manufacturing in period 0 is the present value of the wage differ- ential in period 1 (βk1), plus the present value of migration costs in period 1 (βv(u)/γ).⁴

4The agent who migrates in period 0 avoids paying the period 1 migration costs. If migration in period 1 is at an interior level, period 1 migration costs equal the present value of the wage differential in period 2.

Figure A6.Equilibrium second period migration (v) as a function of first period migration (u) forβ=0.8,γ=2.5, G=0.5,l0=0 andk0=0.2.

The present value of migrating to Manufacturing in period 0 is therefore β k₁+v(u)

γ

=β (1−G)k0+Gl₀+v(u) γ

.

If the value of this expression is negative, its absolute value is the value of migrating to Agriculture. Foru>0, the cost of moving to Manufacturing in period 0 isu/γ; foru<0, the cost of moving to Agriculture is−u/γ.

Define the difference between benefits and costs of moving to Manufacturing in the first period as

h(u;l₀,k₀)≡β (1−G)k0+Gl₀+v(u) γ

− u

γ. (A3)

(Again, ifh<0, then−his the value of moving to Agriculture.) Using equation (A2), we have

dh du=

⎧⎪

⎨

⎪⎩

−β−1γ if u>q

β²Gγ−1

γ if p<u<q

−β−1γ if u<p

⎫⎪

⎬

⎪⎭. (A4) Period 0 actions are always strategic substitutes foru<pand foru>q. Forq<u<p, period 0 actions are strategic complements if and only ifβ²Gγ >1. When actions are strategic substitutes (for all values of the state variable) the equilibrium is generically unique;β²Gγ >1 is therefore necessary for the ROM to have positive measure, as part (i) of the Proposition states.

Since we are interested in the measure of the ROM as a function ofγ , we hereafter assume thatβ²Gγ >1. Given this condition, we want to characterize the ROM, i.e. the region of the(k,l)plane such that if(k0,l₀)is in this region, there are multiple equilibria in period 0.

An interior equilibrium requires thath=0 and astable interiorequilibrium requires in addition thatdh/du<0, evaluated at the equilibrium. (See footnote 1.) Since we are inter- ested only in stable equilibria, equation (A4) means that we can rule out the possibility of interior equilibria wherep<u<q. We are left with three possibilities: (i) The equilibrium

is interior with 0.5−l₀>u>q, (ii) The equilibrium is interior with−0.5−l₀<u<p, and (iii) The equilibrium is on the boundary, i.e.u= −0.5−l0oru=0.5−l0.

In order to construct the equilibrium, we determine the values of u for which h(u;l₀,k₀)=0 at a stable equilibrium. We first consider the case whereu≥q; here, by equation (A1), v=0.5−l₀−u. We substitute v=0.5−l₀−uinto the function h(·) defined in equation (A3), and solve h(·)=0 to obtain an expression for uas a func- tion ofl0,k0. Denote this function asx(l0,k0). Next, we consider the caseu≤p, where v= −0.5−l₀−u. We use this relation in the equationh(·)=0 and solve foruto obtain a function that we denote asy(l0,k0). These functionsx(·)andy(·)are

x(l0,k₀)≡α+ 0.5β β+1 y(l0,k₀)≡α− 0.5β

β+1

, (A5)

using the definition

α≡ β

1+β((γG−1)l0−γ (G−1)k0).

With this notation, we write the equilibrium correspondence:

u(l0,k₀)=

min{x, 0.5−l₀} if x≥q max{y,−0.5−l₀} if y≤p

. (A6)

The first line states that ifx≥q, then a stable equilibrium isu=x, provided that this value is less than the upper limit of migration, 0.5−l₀; otherwise the labor supply constraint is binding, and all labor moves to Manufacturing. The second line has a similar interpretation.

Thus, there are two equilibria if the initial condition satisfies bothq≤xandy≤p. Using previous definitions, these two inequalities can be rewritten as

0.5 1−γβ²G

(1.0+γβG)(β+1.0) ≤α−ρ≤0.5 γβ²G−1

(1.0+γβG)(β+1.0). (A7) This inequality defines the ROM.

Figure A7shows the graph of the equilibrium migration correspondence for k0= 0.2,G=0.7,β=0.8, andγ =5.

The top kinked line is the graph of min{x, .5−l₀}over the interval wherex≥q. The kink occurs wherex=.5−l0. The top straight line is the graph ofq. The bottom kinked line and the bottom straight line are the graphs of max{y,−.5−l₀}and ofp, respectively.

The overlap of the two kinked lines defines the ROM, givenk0=0.2. If, for example, l₀= −0.05, the two equilibrium values of migration are u= −0.144 (a movement to Agriculture) andu=0.3 (a movement to Manufacturing).

Our assumptionsβ²Gγ >1 andβ≤1 imply thatGγ >1, so the slopexandy(as functions ofl0) are always positive, as shown. We noted above that inequality (6) implies that the slope ofpandq(graphed as functions ofl₀) is negative. Therefore, ifx≥pis satisfied, it holds for large values ofl₀; ify≤qis satisfied, it holds for smalll₀.

The boundaries of the overlap are determined by the solution to x=qand y=p.

DenoteX(k0)as the value ofl₀ that satisfiesx=q, and denoteY(k0)as the value ofl₀ that satisfiesy=p. Some calculation yields the formulae in equation (7) of the text. This step establishes part (ii) of the Proposition.

Figure A7.The equilibrium first period migration (u) as a function ofl0forβ=0.8,γ=5,G=0.7 andk0=0.2.

The vertical distance between the boundaries of the ROM isM, defined in equation (8).

We noted in the text that inequality (6) and the assumptionγβ²G>1 imply thatχ >0.

Therefore, when these two inequalities hold, the ROM has positive measure. This fact estab- lishes sufficiency in part (i) of the Proposition. The denominator ofMis quadratic inγand the numerator is linear, soM→0 asγ → ∞. Thus, the measure of the ROM approaches 0 asγ → ∞. Since the measure is 0 forγβ²G<1, positive forγβ²G>1 and approaches 0 asγ → ∞, it is non-monotonic inγ, as part (iii) of the Proposition states.