Note on Adjustment and the Specific Factor Model

employed. But output is inside the production frontier because the capitallaborratios in the two sectors are not at the levels where marginal productsare equated. What happens to the level of output depends on what happensto the respective marginal products of labor as the Ks rises and as KP falls,L sL Pthus:∆Q = ∆L P ∂QP∂L p∂QS− ∆LP∂L S= ∆LP ·∂QP∂L p¸− ∂QS∂L SClearly the impact on ∆Q will depend on the respective elasticities of substitutionin the two sectors. Notice, for example, that if productivity isconstant, and if it is higher in the private sector, output must rise, since theterm in the brackets is positive. Hence, unemployment of resources is neededfor output to fall. Of course, it may be that productivities are not constant.One might suspect, for example, that the marginal product of labor willnotriseatallwiththeincreasein Ks. 1 What happens to the marginalL sproduct of labor in the private sector? Clearly it must fall since KP ↓.L PWhat happens when wages are rigid downwards? This is likely in atransition economy where the initial social safety net is high. 2 Then thewage rate stays at w 0 , and unemployment results, equal to AB in the upperÞgure. The capital-labor ratio in both sectors stays the same, but there isless full employment. Some labor is unemployed, which is evident in thelower picture where we are at A 0 and B 0 .Outputthusfallsevenmore.Notice that whether wages are rigid or if wages fall to clear the labormarket there is one important fact that this model does not explain: the fallin aggregate labor productivity.• with rigid wages labor productivity is unchanged; output falls due tounemployment, but the capital-labor ratios in both sectors are unchanged• with ßexible wages labor productivity in the private sector falls, but inthe state sector it could rise (since the capital-labor ratio goes up — itcertainly does not fall).1 Whether it does depends partly on the elasticity of substitution between capital andlabor in the state sector. One suspects that this will not be very high, given all theproblems of organization and incentives in the state sector.2 There may be other reasons — such as access to goods and housing — that attachworkers to their enterprises.(1)3