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

Abstract

This paper highlights economic factors determining the choice of technology andopenness in an intertemporal context in the presence of Institutional constraints Inthe labor market. It considers the case in which a more aggressive - developmentstrategy involves an investment in a modern technology. This technology raises thedegree to which real wages and productivity depend on external factors while at thesame time It also raises the expected value of real income. In the absence of Suchinvestment, production takes place in a traditional sector, using a technology thatlimits exposure to external shocks. The analysis evaluates the dependence of thechoice of technology on the volatility of the shocks affecting the economy, theexpected productivity gains, the investment cost associated with the moderntechnology, and the attitude towards risk. It starts with a benchmark case of aflexible wage/employment economy. The dependence of openness, investment, and real wages on the attltuae towards risk is derived for such an economy. The paper thenproceeds to analyze the implications of departures from the benchmark model.Specifically, it evaluates the effects of minimum wage policy on the choice oftechnology. it is demonstrated that institutional constraints in the labor market tendto discourage adoption of new technologies. The importance of this effect dependson the volatility of the underlying shocks. A rise In the volatility tends to beassociated with a drop in the degree to which a given institutional structureconstrains 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.