Abstract
This paper analyzes a stylized small open economy that consists of two tradable output-producing sectors: a manufacturing sector and a (mainly tourism-related) services sector. Assuming sectoral differences based on stylized facts, we explore the impact of higher labor standards in the manufacturing sector on the long-term prospects of the economy using comparative dynamic exercises to analyze changes in relative prices, foreign capital flows, and the sectoral distribution of investment and output. We find, in particular, that imposing higher standards across the manufacturing sector could, under certain conditions, shift the structure of the domestic economy in favor of that sector. This result is driven by changes in relative profitability in the presence of learning-by-exporting.
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