A MODEL OF EMPLOYMENT CREATION IN AN OPEN DEVELOPING ECONOMY

Abstract

THE traditional remedy for unemployment in industrialized countries is to expand aggregate demand; but the conventional income-expenditure model used to justify such policies is widely felt to be inappropriate for developing countries.1 In this paper we attempt to build a macroeconomic model for developing countries which does not suffer from the defects of the incomeexpenditure model, and we use it to analyze employment creation policies. Our model is based upon the recent work in the theory of temporary equilibrium of economists such as Barro and Grossman (1971, 1976) and Malinvaud (1977). They argue that macroeconomics is best analyzed in terms of models where firms and consumers maximize subject not only to prices and wage rates, but also to quantity constraints on the amounts they can buy or sell. In our model, unlike Barro and Grossman or Malinvaud, we assume there are two production sectors, the urban and the rural, whose outputs are traded on international markets at prices (in foreign currency) which the home country cannot affect. This means that a general increase in demand will lead, not to greater employment, but to a worsened balance of trade. But the crucial assumption in our model which differentiates it from all other such macro-models, is that the decision-making (utilitymaximizing) unit for labour supply is the extended family, which supplies labour simultaneously to both sectors. In the urban sector the family is assumed to face an employment constraint because the urban wage rate, though not inflexible, is assumed always to lie above its market-clearing level. (This might be the result, for example, of trade union activity, minimum wage laws or the practices of multinational corporations.) The rural labour market, however, is assumed to clear. Thus, the family chooses its rural labour supply and consumption demands to maximize utility, taking into account its urban employment constraint, as well as prices and wage rates. By using this framework we attempt to make our model more relevant to the experience of developing countries than is the conventional incomeexpenditure model. The assumption that the urban labour market does not clear means that open unemployment is a specifically urban problem. But as the rural labour market is assumed to clear, rural employment can always be obtained at some wage rate. Furthermore, it is found useful to define employment in terms of family work-hours, rather than individuals hired; for our aim is to examine the relative efficacy of various types of policy for employment creation, not to focus on the mechanics of the migration * We would like to thank a referee for helpful criticism. ' See Berry and Sabot (1978) for a critique.