Trade and Employment From Myths to Facts - International Labour ...

Chapter 3: Assessing the impact of trade on employment: Methods of analysis
The model may admit a wide range of labour types, degrees of mobility, forms
of segmentation, costs and randomness of search depending on the assumptions
deemed appropriate by the author. 37 Models with large numbers of labour categories
are not uncommon and significant wage differences are often assumed, because of
the assumption that skilled labour can compete with unskilled labour but not vice
versa. This may be somewhat unrealistic, but skill categories are nonetheless useful
ways of demarcating contours of labour mobility within a given sector.
Efficiency wage theory has also occasionally been integrated into applied models
(Shapiro and Stiglitz, 1984). In LDCs, many firms pay workers higher than a marketclearing
wage. Efficiency wage models explain this stylized fact by noting the
principal-agent problem facing employers as workers may elect to work with less intensity
than specified in the employment contract. One solution is monitoring, but
this is expensive. Instead, workers are paid more to elicit higher productivity. This
raises the cost of job loss to the worker and reduces shirking and turnover, attracts
the best workers in the labour market and improves morale and productivity of
workers happy to have a “really good” job.
In LDCs, efficiency wages may also have a biological component as caloric
intake actually improves energy and effort and at the same time reduces absenteeism
due to illness. While providing a theoretically cogent argument for high unemployment
rates in developing countries, efficiency wage theory has not shown partic ular
empirical strength. Since the optimal incentive wage is taken as a function of the
unemployment rate, a rate that is very high when informal workers are considered
unemployed, the efficiency wage premium is probably very small in LDCs.
Many structural CGE models do use a form of the Beverage curve, or wage
curve, that relates search time to vacancies of employers (Gibson and van Seventer,
2000; Guichard and Laffargue, 2000). The curve serves to define the path of nominal
wages in labour-market adjustment. When the rate of unemployment is higher than
usual, nominal wage growth slows, and vice versa. In most CGE models, the agents
(workers, firms and government) only control nominal variables, while general equilibrium
essentially converts these nominal values into real, setting the stage for a
reaction to the outcome in the next period. Reasonable paths for nominal variables
are then required, which implies something like a Beverage curve for each segment
of the labour market. Nothing prevents spillover here, such that unemployment in
the skilled labour market reduces the rate of nominal wage growth for unskilled
workers. It is also easy to build in a minimum wage option and then turn it on and
off to see what the effects on employment and other variables, such as poverty,
might be.
One innovative modelling technique in dynamic models is to use
“complementary slackness”, a term borrowed from the linear programming framework,
as discussed above. Here, the labour constraint is written where
37 Given the degree of aggregation at which most CGE models operate, it is not necessary to assume
that any firm can substitute labour for capital, yet, for the sector as whole, it appears that substitution
has taken place due to the changing patterns of aggregation.
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