Protection, Underemployment and Welfare

Sugata Marjit and Hamid Beladi

No 97-24, EPRU Working Paper Series from Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics

Abstract: A small open economy operates with a unionized fixed wage import-competing sector and an informal “self-employed” sector or “small-firm” sector with perfect capital mobility between the two. Productivity varies across people in the flex wage sector. We first characterize an “underemployment” equilibrium and then show how protection may adversely affect the degree of underemployment. Tariff may not act as a second best instrument in this framework. The welfare result is derived for alternative job rationing schemes in the fixed wage sector. Our results on tariff-reform are consistent with some recent empirical evidence.

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