Labor Market Implications of Limited Integration

Abstract

Globalization, in its multiple interpretations, is seen by many people as a great possibility of improving living standards in developing countries. Trade and financial integration can encourage competition, technology transfers and specialization according to comparative advantage principles. Indeed, after decades of protectionism with very poor results, many countries have actively opened their economies to global competition in search for such great opportunities. Although in many cases the results are encouraging, for a vast group of countries the last two or three decades have been years of turmoil, stagnation and financial crises. These complications have enhanced the criticisms across the world to the process of global integration (Stiglitz (2002)). This paper argues that many of these costs follow from governments’ policies aimed to limit or restrict the scope of integration of countries with the rest of the world. In the presence of international technology differences, limited or restricted integration may generate wage and employment adjustments that could be avoided if countries were to embrace globalization without restrictions. I present a very stylized model where financial integration leads to specialization. In this setting, countries that avoid specialization through trade distortions have much greater downward pressures on wages than countries that do specialize. Moreover, if non-tradable prices are downward rigid and there are some limits to the current account deficits countries can run, employment costs may arise. The model shows that these costs may be greater with a limited globalization strategy than with a laissez-faire policy.Globalization, wages, employment, technology differences, capital flows