Import Competition and Macro Economic Adjustment under Wage-Price Rigidity

Abstract

The paper analyzes the problem of short-term adjustment to a fall in the price of competing imports when thee is wage and price rigidity. This is done in terms of a two-sector model which incorporates a domestically producible import good and a semi-tradeable home good. The effect of a fall in import prices on domestic employment, prices and the balance of payments under nominal or real wage rigidity is analyzed in the various market disequilibrium regimes. The possible responses in terms of demand management and exchange rate (or tariff) policy as well as supply management are analyzed. The theory is then applied to the stagflationary environment of the 1970s within a modified framework in which the price of imported raw materials has simultaneously risen. This helps to show how the above adjustment problem crucially depends on the nature of the underlying macroeconomic environment.