Cumulative Effects of Labor Market Distortions in a Developing Country

This paper considers a small open economy with an input–output industrial structure that creates vertical linkages and multiple equilibria. An imperfect labor market is introduced by assuming unionized labor. It is shown that a deregulation of the labor market may trigger a large, discontinuous expansion of industrial output, as reduced wage costs start a circular, cumulative process in which expansions of the up- and downstream industries promote each other. Centralization of collective bargaining may, however, also be conducive to industrialization.