The impact of macroeconomic adjustment on poverty in the presence of wage rigidities

Abstract

The paper examines the effects of macro-economic policy on poverty when the labour market is subject to partial wage rigidity. It shows that the orothodox assumption of a perfect labour market ignores a number of important conflicts arising from macro-economic policy. Specifically, it demonstrates that an expenditure switching policy will have greater adverse effects on the formal sector compared with the informal sector, and this has implications for poverty. Under reasonable assumptions about the incidence of poverty in these sectors, the paper suggests that more confident predictions about poverty outcomes are possible, although in the last analysis, theoretical ambiguity is always present. Whether the rigid wage case gives significantly different predictions from the orthodox model is shown to depend critically on the poverty level among the unemployed. If this is similar to that found in the formal sector, the difference between the two models is only quantitatively important when the share of formal sector employment is large. In this case, the rigid-wage model indicates less favourable poverty outcomes. However, if poverty levels are high among the unemployed, the rigid-wage model predicts more favourable effects.