Real wage rigidity and optimal commercial policy in less developed countries

Abstract

This paper examines optimal commercial policy in an LDC in which there is a rigid real wage and imports consist of both final and non-competitive intermediae inputs. The nature of optimal commercial policy depends sensitively upon the composition of imports. When export promotion is hampered by import quotas abroad or difficulties in extending export subsidies, protection will often be optimal in economies that import intermediates but not in economics that import only final goods. The results for the full optimization case establish that there is a general presumption trade policy should be biased in favor of export promotion, although there are well defined conditions under which an import-substituting regime is optimal.