Does Trade Increase Employment? A Developing Country Perspective

Transcription

1 Does Trde Increse Employment? A Developing Country Perspective By Sugt Mrjit City University of Hong Kong nd Center for Studies in Socil Sciences, Indi Hmid Beldi University of Texs t Sn Antonio 005 Address for correspondence: Hmid Beldi, Deprtment of Economics, College of Business, University of Texs t Sn Antonio, Sn Antonio, T 7849, Phone: , Emil: hmid.beldi@uts.edu

2 Abstrct e introduce n urbn informl sector in the stndrd Hrris Todro model. bor is mobile between the rurl nd the informl sectors nd cpitl is mobile between the urbn forml nd informl sectors. In this structure we show tht triff designed to protect the forml sector would increse totl unemployment. iberl trde policy in the form of decline in triff rises employment nd informl wge under very resonble conditions. iberliztion process my hurt both orgnized mnufcturing nd trditionl griculture nd led to booming informl sector. JE clssifiction: F 16; O 17; J 31; J 4 Keywords: Trde Policy, Employment, Informl ge 1

3 I. Introduction hether trde helps or hurts employment hs been topic of never-ending debte mong economists, policy mkers nd ctivists. Such debte gets even more intense for developing countries experimenting with trde relted reforms, since rising unemployment tends to ggrvte the problem of poverty nd inequlity. Typiclly, when triffs come down people lose jobs in the import competing sector. As consequence exportbles nd totl employment cn go up. But due to remrkble medi coverge of negtive impct of reforming policies, rising unemployment in the deregulted sectors cn crete huge impct on public opinion wheres expnding sectors hrdly mke the news. hile totl unemployment will be determined by the reltive size of contrction nd expnsion, models of trde policy nd unemployment hve to rely on ifs nd buts i.e. on specific conditions tht ffect ggregte unemployment. In this pper we use conventionl Hrris Todro (HT) structure with n informl sector nd obtin the result under very resonble ssumptions, tht triff contrcts employment nd rises open unemployment. Vrints of HT structure hve been used to look t the impct of policies on open unemployment nd welfre. Interested reders my look t Beldi nd Mrjit (1996), Mrjit nd Beldi (003), nd Fields (005). 1 e relte our pper to prticulr strnd of HT literture tht dels with the informl sector. Gupt (1997) introduced informl sectors in HT model. But the urbn informl wge in such models is less tht the rurl wge, s expected urbn wge hs to be equl to the rurl wge nd the urbn forml wge is greter thn the rurl wge. Csul empiricism suggests tht in the developing

4 world there is fir bit of mobility between the urbn informl sector nd the rurl sector. In our frmework workers get the sme wge in both sectors. The urbn informl sector drws lbor from the rurl sector nd cpitl from the urbn forml sector. Such mobility ssigns pivotl role to the informl sector. The wy we set up the model llows workers the choice of either working in the informl sector or going bck to the rurl sector nd of course the choice of witing in the pool of unemployed. One my imgine the urbn informl sector to be locted in the periphery of the city, between the forml nd the rurl sector. Empiriclly the significnce of the urbn informl sector hs been understood in mny ppers. Agenor (1996) provides n elegnt survey on the size of informl sectors in developing countries. By quoting numerous studies, informl lbor force ccounts for more thn 70% of totl lbor force. Segmented lbor mrkets nd implictions of development policies in such set up hve been nlized in Agenor nd Montiel (1996). Drwing on erlier ppers by Crruth nd Oswld (1981) nd Agenor nd Montiel (1996) nd Kr nd Mrjit (001) nd Mrjit (003) looked t the possibility of rising informl wge nd employment when lid off workers from the forml sector crowd into the informl sector. But somehow employment effect of trde policy in stndrd HT structure with n informl sector is lrgely bsent in the literture. Moreover our pper provides n lmost unmbiguous result of rising unemployment with protection. It is difficult to obtin dt on informl sectors in ny country. However, there is some scttered empiricl evidence which shows tht during the recent trend in globliztion, developing countries re experiencing n increse in the size of the informl economy. Also Mrjit nd Miti ( 005 ) demonstrte with the figures 3

5 vilble for the informl mnufcturing sector in Indi before nd fter the initition of the reform process, tht the informl wge nd employment hve incresed cross vrious Indin sttes during the post reform period. In our frmework decline in triffs reduces open unemployment through expnsion of employment in the informl sector nd n increse in the informl wge. The result is n outcome of hving lbor intensive urbn informl sector nd is more simple nd generl thn the erlier work of Beldi nd Mrjit (1996) which brings in n intermedite input in the HT structure to get the employment reducing effect of protection. The pln of the pper is s follows. Second section discusses the model nd the equilibrium. The third section dels with the impct of triff when the informl is trded sector. The fourth extends the result by treting the informl good s the nontrded good. The lst section provides some concluding remrks. II. The Bsic Frmework nd Equilibrium This is three sector economy producing (urbn forml mnufcturing good), (urbn informl good), nd Z (the griculturl good). nd use cpitl nd lbor, Z uses lnd nd lbor. bor is freely mobile between nd Z, in the sense tht workers ern the sme wge,, informl in both these sectors. But offers wge, forml wge determined through negotition with the unions. There is open unemployment i.e. the workers migrting from the rurl to the urbn re cn either hng round unemployed witing for forml job which pys > or they cn get in the urbn informl sector or in the rurl sector. They re indifferent between the two. Cpitl moves freely between the urbn forml nd informl sectors erning the sme return, r. 4

6 e ssume tht is n import-competing good enjoying triff, t. On the other hnd,, the informl mnufcturing sector is ssumed to produce trded good in the benchmrk model. ter we introduce the possibility tht is non-trded good. The griculturl good, Z is n export good. Competitive mrkets nd constnt returns to scle technology with diminishing mrginl productivities of fctors re ssumed. Competitive price conditions imply: + r = P ( 1 t) (1) + + r = P () y + R = P (3) Z TZ ij ' s re rurl input-output coefficients, r is the return to cpitl nd R is rentl on lnd. Full employment of lnd nd cpitl ensure tht, TZ Z = T (4) Z + K (5) = here T nd K re inelstic supplies of lnd nd cpitl. Hrris Tdro migrtion equilibrium condition is given by, ( + Z ) Z = (6) Note tht (6) cn be rewritten s modified full-employment condition for lbor. + = Z (7) Z ith given prices nd triff rte, t, one cn determine, r, nd R from (1) (3). Fctor prices in turn determine fctor proportion. Now from (4) we cn determine Z. 5

7 Then (5) nd (7) determine nd. This completes the determintion of equilibrium. e ssume tht is lbor intensive nd is cpitl intensive, n ssumption which hrdly needs ny justifiction. However, the fctor intensity ssumption implies, < 0 or, > (8) Note tht on, >, cpitl intensity ssumption is bit stronger thn the usul i.e. > (9) et us define (8) s the stronger version of intensity ssumption nd the weker version is given by, > > (10) Under the weker version, the informl sector becomes effectively the cpitl-intensive sector. (10) Accommodtes kind of fctor intensity reversl if goes down wy below i.e. wider is the forml wge gp, we my hve fctor intensity reversl. Henceforth, we shll ssume (8) holds nd ssume wy ny possible fctor intensity reversl. III. A Reduction in triffs et us trce through the chnges in equilibrium s t is reduced. A decline in t reduces r, increses nd reduces R. This follows directly from equtions (1) (3). 6

8 reduces A decline in R mkes people use lnd more intensively nd with given T tht Z [from (4)] nd. As the RHS in (7) increses with decline in Z Z, the Z HS reduces with decline in ( r) r) ( ) ( /. Also, ) increses with n increse in / nd ( /. Hence, the lbor constrint [(7)] becomes less binding nd the cpitl constrint [(5)] becomes more binding, This leds to the well known Rybczynski type result incresing the lbor-intensive (urbn informl sector) nd contrcts the cpitl intensive (urbn forml mnufcturing good). Now from (7) we cn write totl employment, E, s E + + ZZ = + By now we know tht = 1 (11) must hve gone down nd ( / ) lso hs gone down. E must increse. Therefore, we cn write the following proposition. Proposition I: Under the stronger fctor intensity rnking decline in triffs must increse totl employment. The exct proof is given in the ppendix. Note tht downsized urbn forml sector, with n expnding urbn informl sector nd rising informl wge must reduce open unemployment in the economy. A decline in triffs not only contrcts forml mnufcturing, but lso trditionl griculture. The existing set of informl nd rurl workers must gin s is higher now. Displced workers from the forml sector lose s they were getting. Some of those who were in the pool of open unemployed my give up hope nd join the informl sector. 7

9 Typiclly drop in t will reduce the expected wge rte in the urbn forml sector nd hs tendency to reduce open unemployment. But in the stndrd H T frmework people migrting to griculture depresses the wge rte in griculture. Therefore, the effect on expected wge rtes is mbiguous, so is for unemployment. However, in our frmework in fct goes up s displced cpitl from the forml sector goes to the informl sector. This is must when there is not much of chnge in P. Here drop in t unmbiguously reduces totl unemployment or increses totl employment. It is the rise in the informl wge which is striking outcome becuse the conventionl wisdom will be drop in s more people crowd into the informl segment. But s cpitl leves the forml sector nd s r goes down, cpitl-lbor rtios in ech sector go up, driving up. Not only the displced workers from the forml sector re bsorbed in but higher lso ttrcts more griculturl workers to the informl sector rising overll employment. Also note tht the verge wge which is weighted verge of forml wge nd is given by, = + ( + ) Z 1 = + (from (4)) = + 1 = + [ + ] = 8

10 Clerly, the verge wge is nothing but itself. Hence, the verge worker must gin from triff reform. Therefore, rise in must men rise in nd hence the welfre level of n verge worker. IV. The Non-Trded Informl Sector If the urbn informl good, is non-trded, we need seprte eqution for determining the equilibrium P by blncing demnd nd supply in this sector. et us look t the sequence of outcomes following decline in triff in such context. In our erlier nlysis definitely expnds due to the ssumption of fctor intensity rnking between nd. Now n increse in reduces P to cler the mrket for the informl good nd decline in P tends to reduce, offsetting the positive effect on employment. However, decline in t nd decline in P hve opposite effects on demnd for. ht we hve shown in the ppendix [(13A)] suggests tht high elsticity of ) substitution in demnd ( will be sufficient condition to reinstte our erlier result. In fct, it is well known tht if, Pˆ 0 i.e. in the limit it mimics the cse with trded informl sector. More generlly, even if goes down, strong elsticity of fctor substitution in, σ, will men n increse in employment. But there is every possibility tht the informl wge will go up. One hs to relize tht highσ, reduces ( significntly nd workers with depressed wges do not hng round in the hope of job nd turn bck to, incresing employment. ) 9

11 Proposition II: If is the urbn non-trded sector, decline in triffs will increse totl employment provided tht σ nd re strong enough. For proof of this proposition, see the derivtion of (13A) in the ppendix. V. Relted Discussion It is well known in the HT frmework tht employment nd ggregte lbor income my move in opposite directions following policy chnge. Aggregte lbor income in our model is given by. + + Z (1) Z = htever hppens to employment, ggregte lbor income increses with n increse in, the informl/rurl wge. ht we hve shown here is tht decline in t cn simultneously increse employment nd rise, provided the condition (13A) holds. If P does not move much, must increse. If P does chnge lot, cn still go up [see (10A) in the ppendix]. The weker fctor-intensity rnking condition, > leds to cpitl intensive informl sector, s substntil wge gp mkes worker s shre of verge cost in quite high reltive to the informl sector. Therefore, drop in t my ctully increse nd reduce. et E my very well increse since rise in will lwys hve positive effect on totl employment. As there is generl consensus tht the informl sector is lbor intensive compred to forml sectors, we 10

12 prefer to retin the stronger fctor intensity ssumption s preserved usul fctor intensity rnking. Another point to note in this context is tht rise in the effective price of Z, my be through n increse in prospects for exports or through n increse in productivity is going to increse unemployment. A rise in P Z does not chnge. But n increse in Z reduces totl lbor vilble for the production of nd. Since is cpitl intensive, due to the Rybczynski effect, goes up nd goes down. Informl sector E contrcts but expnds, more people wish to hng round for the job in the forml sector, incresing the extent of open unemployment. One issue tht seems to be left open is the pttern of trde. As t goes down both nd Z contrct. This mens tht import-competing output nd export production both decline. A nturl query is how to sustin blnce of trde. Of course s Px (1+t) nd P drop reltive to tht of Z, exportble surplus cn very well increse. If not, income effect will mke sure tht consumption djusts to blnce of trde constrint. But simple extension of the bsic model will be much more relistic. Consider sitution where we lso hve sector which uses skilled lbor nd cpitl nd produces n exportble. A drop in t, by reducing r will increse skilled wge nd skilled output of the exportble. This cn be dded without ltering ny of our bsic results. Skilled lbor, just s cpitl, cn be ssumed to be scrce input nd fully employed. One dditionl interesting result tht one my obtin in the extended model hs to do with the worsening of unskilled/skilled wge gp following drop in t if cpitl s shre in verge cost is greter in the skilled sector thn the unskilled sector. 11

13 VI. Concluding Remrks e ddress one of the most controversil issues in trde policy of the developing ntions. Does trde increse employment? e rgue tht decline in triff helps crete jobs in the informl sector nd increse informl wge t the sme time even when workers re lid off from the forml sector. This my ccompny decline in rurl employment. But overll employment must increse. The pivotl role of n urbn informl sector is justified by the fct tht if we did not hve the informl sector in our model we could not hve obtined totlly different result. A drop in t will reduce urbn employment nd reduce, the rurl wge rte. Although there will be offsetting effects on open unemployment, rurl workers would hve been definitely worse off nd unemployment could esily go up. It is the informl sector which drws in cpitl, preserves nd rises employment nd lso llows the informl wge to increse. Even if people leve rurl res, open unemployment is not llowed to grow. 1

14 Footnotes 1 For relted studies on H-T Model see Khn (198, 198b), Gupt (1993, 1997), Btr nd hiri (1987, 1988), Cho nd u (199, 1995) nd buuchi (1998,1993) mong others. 13

15 Appendix Effect of chnge in triff () t : Using (4) nd (7) we derive (1A) Z + = T (1A) TZ + K (A) = Differentiting nd using ^ to denote proportionl chnge we get, λ ˆ + λ ˆ = δ ˆ (3A) λ ˆ + λ ˆ = δ ˆ (4A) ( δ, ) > 0 δ K Derivtion here follow Beldi nd Mrjit (1996). Now from competitive price conditions we get, τˆ rˆ = 1 ( τ + t) K ˆ ˆ P = (5A) τˆ ˆ > 0 s τ ˆ < 0 There fore we hve, δ ˆ λ δ ˆ K λ ˆ + = = λ λ ( δ λ δ λ ) K ˆ 14

16 here, λ ˆ < 0 (by stronger fctor intensity ssumption), hence So tht, λ ˆ δ ˆ = λ ˆ ˆ δ K = K λ λ A > [ λ δ + λ δ ] ˆ A, 0 Pˆ τˆ Pˆ ˆ = A = A + ( τˆ ) A Note tht when is trded good nd P is given, ˆ < 0, ˆ > 0. If is non-trded good, demnded for nd supply of must mtch loclly. et us postulte demnd function for. ˆ = τˆ ˆ (7A) D 1 P A chnge in τ hs both income nd substitution effects on demnd for. hile the substitution effect is negtive i.e. drop in τ reduces D, the income effect cn go either wy. 1 cptures both. is own price effect nd in generl equilibrium ny chnges in will hve income effect s well. e will ssume their substitution effect domintes P y 1 nd, re positive Equting (6A) nd (7A) we get the equilibrting chnge in P s, Pˆ ( τˆ ) A = ˆ Pˆ 1 τ A + (8A) or, 15

17 Pˆ A τˆ 1 + = A + < 0 (9A) Therefore, ˆ = τˆ ( A) K A τ ˆ τˆ = A A τˆ = [ ] + A 1 (10A) Therefore, ˆ > 0 if > 1 e now look t the effect of decline in t on the totl unemployment E. E = + + ZZ = 1 (11A) ˆ E > 0 iff + 1 < 0 16

18 ˆ E > 0 iff ( ˆ) ˆ ˆ σ r B + < 0 1 δ λ + δ Kλ where B = < 0 λ Hence, E > 0 iff σ ˆ + ˆ τ B < 0 (1A) 1 It is now redily vilble from (1A) tht since τˆ < 0 nd B < 0, ˆ > 0 if ˆ > 0. e lredy noted tht for for P ˆ = 0, ˆ > 0 s τ ˆ < 0 [from(5a)]. Therefore, E must go up when τ goes down the min proposition of the pper. The generl expression for (1A) is given by (fter substitution for ˆ ). σ τˆ τˆ B = τˆ σ 1 ( + A) ( + A) Therefore s τ ˆ < 0, ˆ > 0 iff, E 1 1 E B 1 σ > ( + A) 1 B 1 Since the brcketed term is RHS (13A) is negtive, sufficient condition for n increse in employment following decline in t is given by, 17

19 1 > ( + A) 0 hich is lso the condition for n increse in. 18

20 References Agenor, P.R. (1996). The lbor mrket nd economic djustment. IMF Stff Ppers, 3, Agenor, P&P. Montiel, 1996, Development Mcroeconomics, Princeton, NJ: Princeton University Press. Btr, R. nd hiri, S. (1987), Imported technologies, urbn unemployment nd the North-South dilogue; Journl of Development Economics, 5(1), Februry, 1-3. Btr, R. nd hiri, S. (1988), bour Turnover Cost nd the Curious Properties of the Mobile Cpitl Hrris-Todro Model; Europen Economic Review, 3(6), July, Beldi, H. nd Mrjit, S. (1996), An Anlysis of Rurl-Urbn Migrtion nd Protection; Cndin Journl of Economics, 9(4), November, Crruth, A&A. Oswld, 1981, The determintion of union nd non-union wge rtes, Europen Economic Review, 16, /3, Cho, C. nd u, E. (199), Cpitl mrkets, urbn unemployment nd lnd; Journl of Development Economics, 38(), April, Cho, C. nd u, E. (1995), Interntionl Cpitl Mobility, Urbn Unemployment nd elfre; Southern Economic Journl, 6(), October, Fields, Gry S. (005), A elfre economic nlysis of lbor mrket policies in the Hrris-Todro model; Journl of Development Economics, 76(1), Februry, Gupt, M.(1997), Informl sector nd informl cpitl mrket in smll open lessdeveloped economy; Journl of Development Economics, 5(), April, Gupt, M.(1993), Rurl-urbn migrtion, informl sector nd development policies A theoreticl nlysis; Journl of Development Economics, 41(1), June, Kr, S. nd Mrjit, S. (001), Informl Sector in Generl Equilibrium: elfre Effects of Trde Policy Reforms; Interntionl Review of Economics nd Finnce, 10(3), Khn, Ali (198), Socil Opportunity Cost nd Immiserizing Growth: Some Observtions on the ong Run versus Short; Qurterly Journl of Economics, 97(), My,

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