Labor Markets and the Choice of Technology in an Open Developing Economy

Joshua Aizenman

NBER Working Paper No. 1998 (Also Reprint No. r1253)
Issued in August 1986
NBER Program(s):International Trade and Investment, International Finance and Macroeconomics

This paper highlights economic factors determining the choice of technology and

openness in an intertemporal context in the presence of Institutional constraints In

the labor market. It considers the case in which a more aggressive - development

strategy involves an investment in a modern technology. This technology raises the

degree to which real wages and productivity depend on external factors while at the

same time It also raises the expected value of real income. In the absence of Such

investment, production takes place in a traditional sector, using a technology that

limits exposure to external shocks. The analysis evaluates the dependence of the

choice of technology on the volatility of the shocks affecting the economy, the

expected productivity gains, the investment cost associated with the modern

technology, and the attitude towards risk. It starts with a benchmark case of a

flexible wage/employment economy. The dependence of openness, investment, and real wages on the attltuae towards risk is derived for such an economy. The paper then

proceeds to analyze the implications of departures from the benchmark model.

Specifically, it evaluates the effects of minimum wage policy on the choice of

technology. it is demonstrated that institutional constraints in the labor market tend

to discourage adoption of new technologies. The importance of this effect depends

on the volatility of the underlying shocks. A rise In the volatility tends to be

associated with a drop in the degree to which a given institutional structure

constrains the move to the new sector. Thus, turbulent periods provide opportunities for structural shifts in favor of the new sector. The analysis assesses both the positive aspects of policies and the welfare costs associated with departures from fully flexible labor markets. It also discusses the interaction between institutional structure of the labor market and the use of protective measures that attempt to reduce exposure to external shocks.

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Document Object Identifier (DOI): 10.3386/w1998

Published: The Journal of Development Studies, Vol. 25, No. 2, pp. 210-225, (January 1989).

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