Exchange rate devaluation and labor absorption in a foreign exchange constrained economy : The Colombian case

The paper revolves around the question of labor absorption in the process of economic development. The study deals specifically with Colombia, however it is felt that the principal findings may also prove valid for other less developed countries in similar situations. One section of the study investigates the effect of exchange rate devaluation on labor absorption in a foreign exchange constrained economy within the framework of a two-gap model. The model is specified in terms of a family of production functions that does not limit a priori the elasticity of substitution to a given value. Another section of the study investigates the causes of the employment lag in Colombia's manufacturing sector. Particular attention is given to the rate of growth of the real wage as an explanatory variable. Chapter I presents an over-view of Colombia's unemployment and trade problems. The chapter also contains a brief review of explanations that have been advanced to account for the employment lag in the manufacturing sector of less developed countries. Chapters II and III present a review of a variety of two-gap models. The policy implications of fixed coefficients Harrod-Domar type two-gap models are compared and contrasted with the policy implications of Nelson's neoclassical model. Chapter IV contains a reformulation of Nelson's model with CES production functions and a reassessment of the policy alternatives in light of the more general formulation. The employment generating impact of devaluation is shown to be uniquely dependent on the elasticity of substitution. Chapter V investigates the relationship between the rate of growth of real wages and the rate of growth of employment in Colombia's manufacturing sector over the period 1959-1966. A labor demand relation is derived from a modified Fei-Ranis model of labor absorption, and fitted by the least squares method to a pooled cross section sample of 20 two-digit Colombian industries. The regression results lend support to the market imperfections hypothesis of the employment lag.