Economic Reform and Labor Unions: A General-Equilibrium Analysis Applied to Bangladesh and Indonesia

Noting the trend toward more independent trade unions in developingcountries, this article examines whether the presence of unionsstrengthens or weakens the benefits to be gained from economicpolicy reform. We show that the presence of "passive" unions—onesthat choose their wage-employment contract given the firm'scost-minimizing strategy—increases the welfare gains fromtrade liberalization, because trade reform lowers the wage premiumenjoyed by the unionized sector, reducing a distortion in thelabor market. These gains are amplified when the unions are"active", namely, when they negotiate a contract with the firmthat is off its labor demand curve. Such a contract resultsin featherbedding—paying workers more than their marginalproduct—and trade reform reduces the amount of featherbedding.The policy implication for Bangladesh—a country with strongtrade unions and a protected unionized sector—is thatthe benefits of further trade liberalization may be greaterthan otherwise predicted. In Indonesia, where both unionizationand import tariffs are low, allowing greater independence tounions may preserve flexibility and reward workers better thanthe current minimum-wage policy.     

Markets under price controls in partial and general equilibrium

When parallel markets arise in the face of price or other controls, two aspects of agents' behavior become crucial in analyzing market outcomes. First, sellers' risk will rise with increases in illegal sales, but may also fall with increases in legal sales. If the latter is true, the parallel market price will induce higher output. Second, if consumers can be given access to the price-controlled good without incurring search, queuing and other transaction costs due to rationing, production of the controlled good will be higher. These effects are demonstrated in both partial and general equilibrium.     

Protecting the Vulnerable: the Tradeoff between Risk Reduction and Public Insurance

In a risky world should governments provide public goods thatreduce risk or compensate the victims of bad outcomes throughsocial insurance? This article examines a basic question indesigning social protection policies: how should a governmentallocate a fixed budget between these two activities? In thepresence of income and risk heterogeneities a simple publicinsurance scheme that pays a fixed benefit to all householdsthat suffer a negative shock is an effective redistributionalinstrument of public policy. This is true even when a well functioningprivate insurance market exists, and so the role of public insuranceis not to correct a market failure. In fact, the existence ofa private insurance market means that the public system hasdesirable targeting properties—all but the poor and high-risktake up private insurance. The provision of public goods thatreduce risk for all should therefore be complemented with publicinsurance that (automatically) benefits those who are especiallyvulnerable.     

Adjustment with a Fixed Exchange Rate: Cameroon, Cote d'Ivoire, and Senegal

As members of the Communauté Financière Africaine,Cameroon, Côte d'lvoire, and Senegal cannot use the nominalexchange rate as a tool of macroeconomic adjustment. This articleconsiders these countries' responses to the commodity and oilprice shocks of the 1970s in light of this and other institutionalconstraints. Using a two-sector model, it shows that there existinstruments that, in principle, permit the real exchange ratedepreciation necessary for adjusting to macroeconomic imbalances.The authors interpret the very different adjustment experiencesof the three countries (despite their common economic structureand institutional setting) in terms of different uses of theseinstruments. Alternative assumptions about the labor marketleave the qualitative nature of the results unaltered. Statisticalanalysis of data from the three countries confirms the model'slinking of the current account and real exchange rate with theinstruments of adjustment.     

External Shocks, Purchasing Power Parity, and the Equilibrium Real Exchange Rate

Two approaches are commonly used to determine the equilibriumreal exchange rate in a country after external shocks: purchasingpower parity (PPP) calculations and the Salter-Swan, tradables-nontradablesmodel. There are theoretical and empirical problems with bothapproaches, and tensions between them. In this article we resolvethese theoretical and empirical difficulties by presenting amodel which is a generalization of the Salter-Swan model andwhich incorporates imperfect substitutes for both imports andexports. Within the framework of this model, the definitionof the real exchange rate is consistent both with that of thePPP approach and with that of the Salter-Swan model (suitablyextended). Our model, however, is capable of capturing a richerset of phenomena, including terms of trade shocks and changesin foreign capital inflows. It also provides a practical wayto estimate changes in the equilibrium real exchange rate, requiringlittle more information than is required to do PPP calculations.The results are consistent with those of multisector computablegeneral equilibrium models, which generalize the trade specificationof the small model.     

BEYOND RATE OF RETURN: REORIENTING PROJECT APPRAISAL

Traditional approaches to project appraisal fail in practiceto address two fundamental questions: whether a project belongsin the public or the private sector; and what effect any externalassistance associated with the project has on the country'sdevelopment. The first issue is of general interest to bothnational policymakers and international donors. If the governmentprovides a good or service that would otherwise have been providedby the private sector, the net contribution of the public projectcould be low. The second issue is of particular concern to donors.If financial resources are fungible, the project being appraisedmight well have been undertaken with out external financing.In this case, donor funds are actually financing some other,unappraised project. Both cases argue for a shift in the emphasisof project evaluation away from a concern with precise rate-of-returncalculations and toward broader sectoral analyses and publicexpenditure reviews. In this context, three areas critical forproper project appraisal include a consideration of the rationalefor public intervention, the fiscal impact of the project, andthe fungibility of external assistance.      

The Long-Run Economic Costs of AIDS: A Model with an Application to South Africa

Primarily a disease of young adults, AIDS imposes economic coststhat could be devastatingly high in the long run by underminingthe transmission of human capital—the main driver of long-runeconomic growth—across generations. AIDS makes it harderfor victims’ children to obtain an education and deprivesthem of the love, nurturing, and life skills that parents provide.These children will in turn find it difficult to educate theirchildren, and so on. An overlapping generations model is usedto show that an otherwise growing economy could decline to alow-level subsistence equilibrium if hit with an AIDS-type increasein premature adult mortality. Calibrating the model for SouthAfrica, where the HIV prevalence rate is over 20 percent, simulationsreveal that the economy could shrink to half its current sizein about four generations in the absence of intervention. Programsto combat the disease and to support needy families could avertsuch a collapse, but they imply a fiscal burden of about 4 percentof GDP.