Macroeconomic Consequences of Increased Productivity in Less Developed Economies

Abstract

This paper examines the impact of increased productivity on prices, output, real wage rate and balance of payments. Two alternative forms of productivity are considered: (1) cost saving for a given output level and (2) production increase without a direct decrease in employment. By making use of a simple model of a small open economy that includes some key features of less developed economies, it is shown that increased productivity with monetary and fiscal restraint helps the economy to improve its key macroeconomic variables, such as output, employment, balance of payments, and real wages both in the short and the medium run. Simulation exercises while treating efficiency as an endogenous variable by invoking learning by doing mechanism are also presented. We simulated the model for three kinds of shocks: (1) efficiency shock, (2) tax rate shock, and (3) price of foreign inputs shock. Our results show that all the three shocks would cause output and real wage rate to increase both in the short and the medium run. Similarly in most cases we found that inflation would come down and balance of payments either improve or deteriorate slightly in the short and the medium run. In general, the findings of our paper does not support the fear that increased productivity would lower the real wages of labour and have negative impact on the economy in the long run. The paper concluded while hinting at different measures which might improve productivity.