Terms of Trade, Exchange Rates and Labor Markets Adjustment in Developing Countries

Sebastian Edwards

NBER Working Paper No. 2110 (Also Reprint No. r1198)
Issued in December 1986
NBER Program(s):   ITI   IFM

This paper uses three models of a small open economy to analyze the effects of terms of trade and exchange rate changes (i.e. devaluations) on labor market adjustment. First, a three goods (exportables, importables, non-tradables), four factors model is developed and used to investigate how an exogenous worsening of the intern.ationa1 terms of trade affect labor allocation and wages. Second, a more traditional three goods, two factors model is used, and its results are compared to those of the first case. The analysis is carried out under alternative assumptions regarding wage flexibility: full flexibility, economy-wide (real) wage rigidity, and sector specific real wage rigidity. Finally, a three final goods model with imported intermediate inputs is used to investigate the effects of devaluations on aggregate and sectoral employment. Here the conditions under which a devaluation will be contractionary (i.e. will result in a reduction of employment) are determined.

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Document Object Identifier (DOI): 10.3386/w2110

Published: "Terms of Trade, Tariffs, and Labor Market Adjustment in Developing Countries." From The World Bank Economic Review, Vol. 2, No. 2, pp. 165- 185, (May 1988).

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