Abstract
Many of the developing countries have chosen free trade as their development strategy and been vigorously implementing liberalised trade and investment policies for the last two decades or so. Liberalisation involves both inflow of foreign capital and reduction of protection of domestic industries, structural reforms like deregulating the labour market and integrating the domestic market with the world market.
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Notes
- 1.
The major driving force behind FDI by the MNEs in the developing countries is the higher rate of return on their capital in these countries vis-Ã -vis the international market. Countries with protected domestic markets are likely to attract foreign investment, but only for the purpose of jumping the tariff walls and reaping a good harvest by serving their markets directly. See, for example, Motta (1992) and Yanagawa (1990) for details.
- 2.
However, it has increased to 3.9% during 2000–2004 (World Development Report, 2006). The GDP per capita grew at 2.4% during 2003–2004.
- 3.
This chapter draws upon Chaudhuri (2003).
- 4.
It may be pointed out that in the models of Grinols (1991) and Gupta (1997), it is assumed that the informal sector produces an internationally traded final commodity, which may seem hardly realistic, given the definition of informality. On the other hand, there is enough empirical evidence (see Section 3.6) in support of the fact that the informal sector units mostly produce non-traded intermediaries for the formal manufacturing industries.
- 5.
See footnote 15 in Chapter 5.
- 6.
Perfect labour mobility is compatible with the type of wage differential considered in this chapter. See Chapter 10 in Batra (1973) for an interesting exposition of this issue.
- 7.
The assumption of full-employment of labour in the context of a developing economy may seem to be awkward at the first sight. But in the presence of informal sectors where wages are completely flexible, this assumption may be justified. Datta Chaudhuri (1989), Grinols (1991), Chandra and Khan (1993) and Gupta (1997) consider that in the migration equilibrium in the presence of an informal sector, there does not remain any involuntary unemployment and the informal sector wage rate lies below that of the rural sector. There are also a few variants of the HOS framework with informal sector where full-employment is ensured relying on the complete flexibility of the informal sector wage rate. Marjit and Beladi (1996), Chaudhuri and Mukherjee (2002) and Chaudhuri and Mukhopadhyay (2002) are three of the few papers based on the HOS framework. The difference between the two types of frameworks is that in the models where an HT framework has been followed, wage rates differ between the rural and urban informal sectors, while in the HOS type of papers all the sectors operate at close vicinity and perfect labour mobility between the informal sectors ensures equalisation of the informal sector wage rates. However, in all these papers, there does not exist any involuntary unemployment of labour in equilibrium. Section 6.4 of this chapter has considered the HT case.
- 8.
It may be noted that in a simple fixed wage differential model also, many of the qualitative results remain unaltered. Also one may include P 3(1+t) in the W *(.) function. The welfare effects of trade liberalisation remain unaffected if the net effect on W * of a decrease in t remains the same.
- 9.
See Section 5.3.1 for explanation.
- 10.
The imposition of a tariff on the import-competing sector artificially raises the domestic price of the formal sector’s product from its world price, which would lead to a misallocation of resources between the two traded sectors. Producers would produce more (less) of the importable (exportable) commodity vis-à -vis their free trade levels. tP 3 X 3 measures the deadweight loss to the economy’s welfare resulting from this inefficiency in production.
- 11.
Our assumption is that domestic capital and foreign capital are perfect substitutes. This simplified assumption has been made in Brecher and Alejandro (1977), Khan (1982), Grinols (1991), Chandra and Khan (1993), Gupta (1997), etc. However, in the papers of Beladi and Marjit (1992a, b) and Marjit and Beladi (1996), foreign capital has been treated differently from domestic capital and these two types of capital are not engaged in the same sector of the economy.
- 12.
This means that W * and W move in the same direction. But the proportionate change in W * is not greater than that in W. This is only a sufficient condition to make |θ|>0, which means that the vertically integrated import-competing sector is more capital-intensive than the export sector in value terms.
- 13.
See Appendix 6.1 for detailed derivation of this expression.
- 14.
It should be mentioned that if there are more than one distortion (one of it being tariff protection), an inflow of foreign capital might alleviate some distortion at the expense of aggravating others. So the conditions derived in the chapter may be specific to this model and to distortions chosen. The results may change if another distortion is added or substituted for another one. If, for example, we relax the assumption of perfectly competitive product market for commodity 3 and consider increasing returns to scale, embedded in a monopolistically competitive market, an inflow of foreign capital in the formal sector may increase welfare even with a perfect labour market. A labour market distortion would no longer be necessary to derive the result.
- 15.
In order to analyse the welfare consequence of a tariff reform, one should ideally measure welfare in terms of a strictly quasi-concave social welfare function as apart from the usual income effect there is also a price effect resulting from the change in relative prices of commodities to the consumers. See Section 2.3 in this context.
- 16.
This aspect has been discussed in details in footnote 14.
- 17.
The assumption that the urban informal sector produces a traded final commodity is a simplifying one. Grinols (1991), Chandra and Khan (1993) and Gupta (1997) have used this assumption. This helps us to make the production structure a decomposable one.
- 18.
Another way of introducing capital market dichotomy has been discussed in Section 3.7.
- 19.
Note that the labour endowment has been normalised to unity. So K gives the capital–labour ratio of the economy.
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Chaudhuri, S., Mukhopadhyay, U. (2010). How and How Far to Liberalise a Developing Economy. In: Revisiting the Informal Sector. Springer, New York, NY. https://doi.org/10.1007/978-1-4419-1194-0_6
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