4046 Ann Harrison and Andrés Rodríguez-Clare

equilibrium yields higher wages? In the equilibrium with complete specialization in good 1
the wage is w ¼ l1 p"1 , whereas in the other equilibrium we have w ¼ yl2 p"2 . If condition
(1) is satisfied with strict inequalities then yl2 p"2 > l1 p"1 so wages are higher in the equilib-
rium with complete specialization in good 2 is superior.5
We will say that South has a latent comparative advantage in good i if the opportu-
nity cost of this good given the realization of all Marshallian externalities is
lower than the international price.6 For good 1 this entails yl2/l1 # 1/p" , whereas
for good 2 this is l1/yl2 # p" . Thus, condition (1) with strict inequalities implies
that South has a latent comparative advantage in good 2. The equilibrium with spe-
cialization in good 1 is possible because in this case Marshallian externalities are not
realized, and hence the latent comparative advantage of South in good 2 is not what
determines the pattern of specialization. Thus, the previous results (i.e., existence of
multiple equilibria and the fact that generally the equilibrium with specialization in
good 2 yields higher wages than the one with specialization in good 1) can be rein-
terpreted as saying that a country may be specialized in a sector where it does not
have a latent comparative advantage, and that in this case a policy that induces the
economy to switch to the equilibrium with specialization in the good where there
is a latent comparative advantage could be welfare enhancing (see discussion below).
Figure 1 illustrates the previous results. The curve labeled PPF represents the produc-
tion possibilities frontier for South, which is convex when L 2 < L ! (or Q2 < yl2 L !)
! !
and becomes linear when L 2 $ L (or Q2 $ yl2 L ). The curve labeled PPFNC is the
hypothetical production possibilities frontier when there are no Marshallian externalities
(i.e., a ¼ 0), given simply by a line with slope l1/l2, as in the standard Ricardian model.
Note that the slope of the PPF is the same as the slope of PPFNC at the corner where

Q1

λ1L

PPFNC
PPF

θλ2L λ2L θλ2L Q2

Figure 1 Marshallian externalities and multiple equilibria.