Dynamic two‐country Heckscher–Ohlin model with externality

We extend a dynamic Heckscher–Ohlin model with production externality presented in recent work by Nishimura and Shimomura by assuming a consumable capital good. Following work by Bond, Iwasa, and Nishimura, we define a steady‐state excess demand function and derive the locus of home and foreign capital stocks that are consistent with a steady‐state equilibrium under free trade. Also, we examine the relationship between externality and local dynamics in autarky or under free trade, which includes a phase diagram analysis. Then we show that opening trade can generate expectation‐driven fluctuations in a world trade market.