DP1094 Labour Adjustment and Gradual Reform: Is Commitment Important?

Author(s): Larry Karp, Thierry Paul
Publication Date: January 1995
Keyword(s): Adjustment Costs, Dynamic Tariffs, Markov Perfection, Time Inconsistency
JEL(s): F13, J20, J24
Programme Areas: International Trade and Regional Economics, Human Resources
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1094

We analyse a model in which a government uses a second-best policy to affect the reallocation of labour, following a change in relative prices. We consider two extreme cases, in which the government has either unlimited or negligible ability to commit to future actions. We explain why the ability to make commitments may be unimportant, and we illustrate this conjecture with numerical examples. For either assumption about commitment ability, the equilibrium policy involves gradual liberalization. The dying sector is protected during the transition to a free market, in order to decrease the amount of unemployment. Our results are sensitive to the assumptions about migration.