Uneven Development and Bilateral Conflict

We consider the dynamics of bilateral conflict within the framework of a standard two-country, two-sector model of international trade with increasing returns in one sector. Free trade leads to asymmetric equilibria among otherwise identical countries and, in some circumstances, to uneven development in the sense of persistent disparities in wages, income and welfare. In the latter case, distortionary industrial policy by the less developed country may be welfare enhancing. When the dynamics of policy change are endogenized, the model gives rise to periodic changes in industrial leadership or leapfrogging. Implications of this phenomenon for the empirical literature on convergence are discussed. Blackwell Publishers Ltd 2000.