Unemployment and Economic Integration for Developing Countries

Transcription

1 MPRA Munich Personl RePEc Archive Uneloyent nd Econoic Integrtion for Develoing Countries Hiwen Zhou 5 Deceer 7 Online t htts://r.u.uni-uenchen.de/8333/ MPRA Per No. 8333, osted 6 Deceer 7 4:5 UTC

2 Uneloyent nd Econoic Integrtion for Develoing Countries Hiwen Zhou Astrct While finncil or trde integrtion etween countries y increse the size of the rket nd hels the dotion of ore dvnced technologies, will it lso increse the level of urn uneloyent for develoing country? In this odel, there is uneloyent in the urn sector. Mnufcturing firs engge in oligoolistic coetition nd choose incresing returns technologies to xiize rofits. Finncil firs rovide citl to nufcturing firs nd they lso engge in oligoolistic coetition. We show tht n increse in the wge rte in the nufcturing sector chnges neither the level of technology nor the level of eloyent in the nufcturing sector. While finncil or trde integrtion etween develoing countries leds nufcturing firs to dot ore dvnced technologies, the level nd rte of eloyent in the nufcturing sector will not deteriorte. Keywords: Uneloyent, econoic develoent, finncil integrtion, interntionl trde, choice of technology JE Clssifiction Nuers: F, O, D43. Introduction One iortnt feture of the odern nufcturing sector is the existence of significnt degrees of incresing returns (Chndler, 99). Under incresing returns, verge costs decrese with the size of the rket. For develoing country, the size of the doestic rket y e sll nd incresing returns in the nufcturing sector y not e sufficiently exloited. The size of the rket could e incresed y the oening u of interntionl trde. However, the oening u of trde with develoed econoy y hr the nufcturing sector in develoing country when this develoing country iorts nufctured goods. Alterntively, develoing countries y for custo unions with other develoing countries to increse the size of the rket so tht incresing returns could e etter exloited (Nurkse, 953, Stewrt, 977, McKinnon, 993). While econoic integrtion with other develoing countries cn increse the size of the rket nd hels the dotion of ore dvnced technologies, it y lso hve iortnt nd undesirle effects such s incresing the level of uneloyent of develoing country. One coon concern of the ict of the dotions of dvnced technologies in develoing country is tht jos y e eliinted ecuse dvnced technologies re citl

3 intensive (Sen, 96). Will econoic integrtion ong develoing countries increse the level of urn uneloyent in these countries when ore dvnced technologies re doted? In the st thirty yers, ny develoing countries such s Chin nd Indi hve switched fro iort sustitution to n exort oriented develoent strtegy. As result, interntionl trde ong develoing countries hs incresed significntly. In the cse of Chin, while quite closed until 978, now Chin is one of the lrgest trding countries in the world. A significnt ercentge of Chin s trde is trde with other develoing countries. Since 98s, ny develoing countries hve lso doted olicies ore friendly to foreign direct investent. As result, citl inflows to develoing countries such s Chin hve incresed drticlly. Develoing countries hve lso tried to chieve high levels of econoic integrtion ong theselves through the estlishent of referentil trding greeents. One exle of referentil trding greeents ong develoing countries is MERCOSUR in tin Aeric. This incresed degree of trde nd finncil integrtion ong develoing countries cn led to huge welfre gins for rticiting countries. For exle, Person nd Ingr (98) hve found tht otentil econoic integrtion etween Ghn nd the Ivory Cost could led to gins of ercent to 33 ercent of gross outut for the two countries. In this er, we study the ict of finncil nd trde integrtion etween two develoing countries on the level of technology nd urn eloyent in generl equiliriu odel with incresing returns in the finncil nd nufcturing sectors. The odel contriutes to the literture y deonstrting tht develoing country y not need to worry out n excertion of uneloyent fro finncil or trde integrtion even though finncil or trde integrtion leds to the dotion of ore dvnced technologies. In this odel, consuers derive utilities fro the consution of the griculturl good nd nufctured goods. There re three sectors: the griculturl sector, the finncil sector, nd the nufcturing sector. First, the griculturl sector uses lnd nd lor to roduce the griculturl good. Second, the finncil sector receives deosits fro citl owners nd then rovides the received citl to nufcturing firs. A finncil fir is clled nk. Bnks engge in oligoolistic coetition. Third, the nufcturing sector eloys citl nd lor to roduce nufctured goods. Citl is the fixed cost nd lor is the rginl cost of roduction in the nufcturing sector. Mnufcturing firs engge in Cournot coetition nd choose their technologies to xiize rofits. A ore dvnced nufcturing technology is ssocited with

4 higher fixed cost ut lower rginl cost of roduction. Following Hrris nd Todro (97), we ssue tht the wge rte in the nufcturing sector is exogenously given. One roinent oservtion on develoing countries is tht ny workers re eloyed in the inforl sector (Ruch, 993). Wge rigidity in the forl sector contriutes to the existence of the inforl sector. Wge rigidity could result fro governent regultions or the existence of unions. Alterntively, the wge rte cn e viewed s exogenously given in ewis tye odel in which lrge ount of surlus lor exists. Eiricl reserch on the wge rte during Chin s econoic develoent is rovided y Zhng, Yng, nd Wng (). They rgue tht the wge rte in Chin ws stgnnt until the 99s nd egn to rise only in the lst decde when the ewis turning oint ws reched. First, we study closed econoy. We show tht n increse in the wge rte in the nufcturing sector chnges neither the level of technology nor the level of eloyent in the nufcturing sector. The reson is s follows. The level of technology of nufcturing fir is ffected y the wge rte nd the rice of nufctured goods. An increse in the wge rte in the nufcturing sector cuses the rice of nufctured goods to increse. Since this increse in the rice cncels out the ict of n increse in the wge rte, the equiliriu level of technology in the nufcturing sector is not ffected y chnge in the wge rte in the nufcturing sector. Second, we study finncil integrtion etween two develoing countries. We show tht finncil integrtion leds nufcturing firs to dot ore dvnced technologies. The reson is tht finncil integrtion leds to n exit of soe nks in ech country (however the nuer of nks serving nufcturing fir increses fter finncil integrtion ecuse nufcturing fir is served y nks in the world insted of y nks in the hoe country). Since ech nk incurs fixed cost of citl in roduction, this exit of soe nks releses citl fro the finncil sector nd increses the suly of citl to the nufcturing sector. As result, nufcturing firs choose ore dvnced technologies. In this odel, to focus on how uneloyent is ffected y econoic integrtion, we ke the silifying ssution tht the existence of uneloyent is result of exogenously given wge rte. In relity, the existence of uneloyent cn e result of vrious fctors, such s the existence of efficiency wges (Shiro nd Stiglitz, 984) or dverse selection in the lor rket (Benciveng nd Sith, 997). Frnkel (5) rgues tht in Indi only out % of workers re eloyed in the forl sector. 3

5 Third, we study trde integrtion etween two develoing countries. We show tht trde integrtion leds nufcturing firs to dot ore dvnced technologies. The reson is tht with trde integrtion, higher degree of coetition in the rket for nufctured good leds to lower rofit rgin for ech unit of nufctured outut. To rek even, nufcturing fir roduces higher level of outut. A higher level of outut kes the dotion of ore dvnced technologies ore rofitle ecuse the higher fixed cost ssocited with ore dvnced technology cn e sred to higher level of outut. Finlly, we study joint finncil nd trde integrtion etween two develoing countries. Strting fro finncil integrtion lone, further trde integrtion etween the two countries will led nufcturing firs to dot ore dvnced technologies. Strting fro trde integrtion lone, further finncil integrtion etween the two countries will led nufcturing firs to dot ore dvnced technologies. In ters of the choice of technologies, this er is relted to Zhou (3) who studies odel of rurl-urn igrtion in which firs engge in oligoolistic coetition. In Zhou (3), n increse in the wge rte will not ffect nufcturing fir s choice of technology. Citl ccuultion leds firs to choose ore dvnced technologies, ut y not increse eloyent in the nufcturing sector. Econoic integrtion is not ddressed in Zhou (3). While there re ny studies on finncil nd trde integrtion ong countries (McKinnon, 993; ne nd Milesi-Ferretti, 8; Hufler nd Wooton, ), this er is directly relted to studies on finncil nd trde integrtion in which incresing returns re resent. Trde lierliztion with incresing returns hs een studied y Cho nd Yu (997). One coon sect etween Cho nd Yu (997) nd this er is tht oth odels study the ict of trde integrtion for develoing country. Cho nd Yu hve shown tht trde lierliztion y ggrvte undereloyent nd thus lower socil welfre in generl equiliriu odel. Different fro this er, finncil integrtion nd the choice of technology y nufcturing fir re not studied in Cho nd Yu. Trde lierliztion with incresing returns hs een studied y Gong nd Zhou (4). This er differs fro Gong nd Zhou (4) in soe iortnt sects. In Gong nd Zhou, two countries differ in ters of their efficiencies in the finncil sector nd the wge rte in the nufcturing sector is deterined y rket forces. The ict of finncil integrtion is not studied in Gong nd Zhou. Models of finncil integrtion with incresing returns hve een studied y Mrtin nd Rey (, 4). With incresing returns in 4

6 the finncil sector, they show tht finncil integrtion will increse sset returns. There re soe significnt differences etween their odels nd this one. In their odels, finncil firs engge in onoolistic coetition. Trde integrtion is not their focus nd is not ddressed in their odels. In this odel, finncil firs engge in oligoolistic coetition. The interction etween the finncil sector nd the nufcturing sector is essentil in this study. Joint finncil integrtion nd trde integrtion with incresing returns is studied in Wen nd Zhou (). There re soe significnt differences etween this er nd Wen nd Zhou (). In Wen nd Zhou, there is no griculturl sector. The wge rte in the nufcturing sector is deterined y rket forces. In this er, there is n griculturl sector nd the wge rte in the nufcturing sector is exogenously given. Uneloyent y e the result of vrious fctors, such s the existence of iniu wges, lor rket serch, or efficiency wges. First, Brecher (974) hs studied odel in which uneloyent is result of the existence of iniu wges. Brecher shows tht results vlid in odel of full eloyent y not extend to his odel incororting uneloyent. Second, Dvidson, Mrtin, nd Mtusz (999) hve studied odel in which uneloyent is of the serch tye. 3 They show tht lor rket efficiency is n indeendent source of country s cortive dvntge. Heln nd Itskhoki () hve incororted fir heterogeneity into lor rket serch. Third, Brecher nd Chen () hve studied how interntionl trde, igrtion, nd outsourcing ffect uneloyent in odel in which uneloyent is result of the existence of efficiency wges s in Shiro nd Stiglitz (984). Dvis nd Hrrign () hve incororted fir heterogeneity into efficiency wge odels y introducing differences in onitoring intensities of firs. One key difference etween this er nd the ove ers is tht the choice of incresing returns technologies is not incororted in the ove odels. The incorortion of the choice of technology in our odel is useful in understnding the dete on the reltive gnitudes of the ict of the choice of technology nd the oening u of interntionl trde on the uneloyent rte of country. Since the oening u of interntionl trde induces firs to choose ore dvnced technologies, the ict of the oening u of interntionl trde on uneloyent could e different fro tht in odel in which the oening u of interntionl trde nd the choice of technology re treted sertely nd indeendently. 3 See Dvidson nd Mtusz (4, ) for syntheses of studies of uneloyent nd interntionl trde. 5

7 The ln of the er is s follows. Section estlishes the equiliriu in which ech of the two countries is in utrky. The ict of econoic integrtion on the level of nufcturing technology nd the level nd rte of urn eloyent is studied in the next three sections: Section 3 studies the ict of finncil integrtion, Section 4 exines the ict of trde integrtion, nd Section 5 ddresses the ict of joint finncil nd trde integrtion. Section 6 concludes.. Countries in utrky There re two develoing countries: hoe nd foreign. In this section, we study the cse tht ech of the two countries is in utrky. Without loss of generlity, we focus on the hoe country. Ech individul derives utility fro the consution of the griculturl good nd continuu of nufctured goods indexed y nuer [, ]. 4 nd, lor, nd citl re the three fctors of roduction. The totl ount of lnd in the hoe country is T. The size of the oultion is. Ech individul y suly one unit of lor. The totl ount of citl is K. 5 There re three sectors: the griculturl sector, the nufcturing sector, nd the finncil sector. First, in the griculturl sector, the griculturl good is roduced y lnd nd lor with constnt returns to scle technology. 6 The nuer of individuls eloyed in the griculturl sector is. For the constnt (,), griculturl outut is secified s T. Second, nufctured goods re roduced y citl nd lor nd ll nufctured goods hve the se costs of roduction. The wge rte in the nufcturing sector is exogenously given t w. The eloyent rte in the nufcturing sector is e. Insted of interreting e s the ercentge of workers eloyed in the nufcturing sector, in this odel we interret e s the ercentge of tie tht n individul in the nufcturing sector is eloyed. 7 The nuer of identicl nufcturing firs roducing nufctured good is ( ). Firs roducing the se nufctured good re ssued to engge in Cournot coetition. 4 As discussed in Nery (3), the otivtion of this ssution of continuu of nufctured goods is to eliinte nufcturing fir s rket ower in the fctor rket. 5 With hoothetic reference ssued in this odel, the distriution of ownershi of citl will not ffect the totl dend for the griculturl good nd nufctured goods. 6 Siilr to Benciveng nd Sith (997), we ssue tht the griculturl sector does not use citl s fctor of roduction. 7 One dvntge of this interrettion is tht ech individul in the nufcturing sector hs ositive incoe nd thus ositive consution. 6

8 Third, for ech nufctured good, there re ultile nks in the finncil sector roviding citl for nufcturing firs roducing this nufctured good. A nk chrges n interest rte of R for ech unit of citl rovided to nufcturing fir. riles ssocited with nk usully crry suscrit. The nuer of nks serving nufcturing firs roducing nufctured good is ( ). Bnks engge in Cournot coetition. Siilr to Slinger (988), when there re two stges of roduction nd firs in oth stges engge in Cournot coetition, we ssue tht firs in ech stge tke the rices of inuts s given: nk tkes the interest rte id to deositors s given nd nufcturing fir tkes the interest rte chrged y the nks s given... Utility xiiztion A consuer s consution of the griculturl good is c nd her consution of the nufctured good is c ( ). For the constnt (,) secified s, the utility function of this consuer is ln c ( ) ln c( ) d. () The rice of the griculturl goods is. The rice of nufctured good is ( ). A consuer tkes the rices of goods s given nd chooses the quntities of consution of goods to xiize utility. With the secifiction of the utility function, utility xiiztion requires tht consuer sends ercent of the incoe on the griculturl good nd incoe on nufctured goods. ercent of the.. Profit xiiztion In this susection, we study rofit xiiztion of nufcturing fir nd nk. For nufcturing fir, citl is the fixed cost nd lor is the rginl cost of roduction. To roduce ech nufctured good, we ssue tht there is continuu of technologies indexed y ositive nuer n. A higher vlue of n indictes ore dvnced technology. The fixed cost ssocited with technology n in ters of citl is f (n) nd the rginl cost in ters of lor is (n). Siilr to Wen nd Zhou () nd Gong nd Zhou (4), to cture the sustitution etween fixed nd rginl costs of roduction, we ssue tht 7

9 ore dvnced technology uses higher ount of citl. However, the rginl cost of ore dvnced technology is lower. 8 Tht is, f ' ( n), nd ' ( n). More secificlly, for constnts nd h, the fixed nd rginl costs in the nufcturing sector re secified s f ( n) n, () h ( n) n. () The otivtion of this secifiction of technologies in equtions () nd () is to ensure syetry in the two stges of roduction. With the secifiction of the utility function in eqution (), consuer hs constnt elsticity of dend for goods (the griculturl good nd nufctured goods). With the secifiction of technologies in equtions () nd (), nufcturing fir hs constnt elsticity of dend for fctors of roduction (citl nd lor). Thus in this odel with two-stge oligooly in the roduction of nufctured goods, oth stges hve constnt elsticities of dend. This syetry etween stges kes the odel trctle. For nufcturing fir with outut level x, its revenue is x. With costs of citl f ( n) R nd costs of lor (n) x w, its rofit is x f ( n) R ( n) x w. A nufcturing fir tkes the interest rte chrged y nk s given nd chooses its outut nd technology otilly to xiize rofit. A nufcturing fir s otil choice of outut leds to x w x. Since ech nufctured good is roduced y identicl firs, cointion of this eqution with the result tht the solute vlue of consuer s elsticity of dend for nufctured good is one yields w. (3) 8 There re vrious exles to otivte this ssution on the trdeoff etween fixed costs nd rginl costs. First, evinson (6) discusses the choice of trnsorttion technologies. The loding nd unloding of crgos cn e chieved y two technologies: the usge of longshoreen, nd the dotion of continers. For the usge of longshoreen, if the wge rtes were high, rginl costs were high. The dotion of continers led to high levels of fixed costs ecuse secilly designed crnes, continershis, nd continer orts hd to e uilt. However, rginl costs decresed shrly. Second, Prendergst (99) discusses technology choices in three nufcturing industries: nuts nd olts, iron founding, nd chine tools. He shows tht there is trdeoff etween rginl costs nd fixed costs of roduction in those industries. 8

10 Eqution (3) is the filir condition showing tht nufcturing fir s rice is rku over the rginl cost of roduction w nd the rku fctor is ffected y the degree of coetition. The derivtion of eqution (3) is s follows. For nufctured good, let x i denote reresenttive fir i s outut nd let x i denote the outut roduced y ll firs other thn the reresenttive fir i. So totl outut for nufctured good is x x i i. The clernce of the rket for nufctured good requires tht quntity sulied equls quntity dended: xi x i c x. In Cournot coetition, when fir chooses its outut, it tkes the outut of other firs s given. With this in ind, rtil differentition of x x c leds to i i ( xi x i) xi i in equiliriu, i c i. Tht is, xi i c ( i i ) c c i c x. Since firs re syetric i i x i x nd i. Plugging the ove result x ( n) w leds to eqution (3). x A nufcturing fir s otil choice of technology leds to 9 x x into f ' ( n) R ' ( n) x w. (4) Mnufcturing firs will kee on entering until the level of rofit is zero. Zero rofit for nufcturing fir requires tht x f R x w. (5) The fixed cost for nk in ters of the ount of citl used is f. A nk ys n interest rte of r for ech unit of citl deosited. With revenue of R x, fixed cost of f r, nd cost of ttrcting deosits r x, the rofit of nk is R x fr r x. Bnks serving nufcturing firs roducing nufctured good engge in Cournot coetition. A nk tkes the interest id to deositors s given nd chooses its level of outut to xiize its rofit. R A nk s otil choice of outut requires tht R x x r. Fro nufcturing fir s x 9 The second order condition for nufcturing fir s otil choice of technology is ssued to e stisfied nd is used lter on to sign cortive sttics results. For soe exles of Cournot coetition with zero rofits, see Sections 3.7 nd 4.5 of Brnder (995) nd Zhng (7). 9

11 rofit xiiztion nd the secifictions of costs in equtions () nd (), we hve f R R f x. Using R R f h R x x R R x f R R f f R, nk s otil choice h of outut leds to rginl revenue (left-hnd side of eqution (6)) equls rginl cost (righthnd side of eqution (6)): h R r. (6) Bnks will kee on entering the finncil sector until the rofit of nk is zero. Zero rofit for nk requires tht R x f r r x. (7).3. Mrket clering conditions In this susection, we estlish rkets clering conditions, including rkets for citl, lor, the griculturl good, nd nufctured goods. For nufctured good, the finncil sector s suly of citl to nufcturing firs is ( ) x ( ) nd nufcturing firs dend of citl is ( ) f ( ). In equiliriu, the two should e equl: x f. (8) For the rket for citl, the dend for citl fro the finncil sector is ( ) f ( ) d nd the dend for citl fro the nufcturing sector is ( ) f ( ) d. Thus the totl dend for citl is f d f d. The totl suly of citl in the hoe country is K. The clernce of the rket for citl requires tht f d f d K. (9) The ount of individuls ssocited with the nufcturing sector is. Since the eloyent rte in the nufcturing sector is e, the effective suly of lor in the nufcturing sector is e. The totl dend for lor in the nufcturing sector is

12 ( ) ( ) x ( ) d. Equiliriu in the rket for lor in the nufcturing sector requires tht e x d. () For the lor rket of this econoy, the ount of individuls eloyed in the griculturl sector is nd the ount of individuls ssocited with the nufcturing sector is. The suly of lor is. or rket equiliriu of this econoy requires tht. () With wge rte of w nd ossiility of eloyent of e, the exected return for worker in the nufcturing sector is e w. The return of worker in the griculturl sector is ( ) T. Siilr to Hrris nd Todro (97) nd Zhng (), since worker cn ove etween the nufcturing nd griculturl sectors, in equiliriu the exected returns or utility should e equl in the two sectors: lnd: ( T. () e w ) For the griculturl sector, the return to lnd q is equl to the vlue rginl roduct of T q. (3) For the rket for the griculturl good, the vlue of totl suly is T. Totl incoe in this econoy is the su of lor incoe qt. Thus totl incoe is ew e w, citl incoe r K, nd lnd incoe r K qt. Becuse ercent of this totl incoe is sent on the griculturl good, the totl dend for the griculturl good is ( ew r K qt). The clernce of the rket of the griculturl good requires tht is T ( ew r K qt ). (4) For the rket for nufctured goods, the vlue of the suly of nufctured good x. Integrting over ll nufctured goods, the vlue of totl suly of nufctured goods is ( ) ( ) x( ) d. Since of totl incoe is sent on nufctured goods, the totl

13 dend for nufctured goods is ( )( ew r K qt ). The clernce of the rket for the nufctured goods requires tht xd ( )( ew r K qt ). (5).4. Equiliriu in closed econoy We focus on syetric equiliriu in which ll nufctured goods hve the se levels of outut nd rice. Since ll nufctured goods re syetric, we do not index nufctured good in syetric equiliriu. Since the esure of totl nufctured goods is one, for silicity of resenttion, we dro the integrtion oertor in syetric equiliriu. In this closed econoy, equtions (3)-(5) for syste of 3 equtions defining 3 endogenous vriles e,,,, q, r,,,, n, R, x, nd x s functions of exogenous reters. A syetric equiliriu in this closed econoy is tule ( e,,,, q, r,,,, n, R, x, x ) stisfying equtions (3)-(5). For the rest of the er, the griculturl good is used s the nuerire:. To conduct cortive sttics for this closed econoy, we need to reduce this syste of 3 equtions to sller nd thus ngele nuer of equtions. To chieve this gol, first, fro equtions (6)-(9), the interest rte id to deositors cn e exressed s ( h) f r R. (6) K Second, fro equtions (6) nd (6), the nuer of nks cn e exressed s ( h) K f. Fro equtions (7) nd (6), the level of outut of nk cn e exressed s x K f ( h) f nuer of nufcturing firs is. Plugging the vlue of nd the vlue of x into eqution (8), the K ( h) Kf / f. (7) Third, fro equtions (3) nd (7), the rice of nufctured good is

14 3 Kf h K f w ) ( / /. (8) The syste of 3 equtions is thus reduced to the following syste of three equtions defining three endogenous vriles n,, nd e s functions of exogenous reters: ) ( ' ' ' Kf h K f f, (9) ) ( ) ( ) ) ( /( ) ( Kf h K f, () ) ( ) ( 3 T ew. () Prtil differentition of equtions (9)-() with resect to n,, e, w, nd K yields dk K K d w w de d dn e n n () et denote the deterinnt of the coefficient trix of endogenous vriles in syste (): e n 3. Prtil differentition of equtions (9)-() leds to n,, nd 3 e. As result,. With nonsingulr, unique equiliriu exists for the syste (). The following roosition studies the ict of chnge in the wge rte in the nufcturing sector. Equtions (9)-() re derived s follows. First, eqution (9) is derived y lugging the vlue of x fro eqution (5) into eqution (4) nd then relcing the vlue of with eqution (8). Second, eqution () is derived y dividing eqution (4) y eqution (5), relcing the vlue of fro eqution (), relcing the vlue of x fro eqution (), nd relcing the vlue of fro eqution (8). Third, eqution () is derived y lugging the vlue of fro eqution () into eqution (). Turnovsky (977, ch. ) discusses conditions for the existence of unique locl equiliriu nd unique glol equiliriu. He deonstrtes tht conditions for the existence of unique glol equiliriu re very strict. Thus we focus on the existence of unique locl equiliriu.

15 Proosition : An increse in the wge rte in the nufcturing sector chnges neither the level of technology nor the level of eloyent in the nufcturing sector. The eloyent rte decreses. Proof: An liction of Crer s rule on the syste () leds to dn, d w d, d w de d w n 3 w /. Fro Proosition, n increse in the wge rte in the nufcturing sector does not led nufcturing firs to use sller ount of lor in roducing ech unit of outut. The reson is s follows. Fro eqution (3), n increse in the wge rte in the nufcturing sector increses the rice of nufctured good. Since the nuer of nufcturing firs roducing nufctured good does not chnge (fro eqution (7)), n increse in the wge rte in the nufcturing sector leds to the se roortionl increse in the rice of nufctured good. Since this rice increse sors the ict fro n increse in the wge rte in the nufcturing sector, the equiliriu level of technology of nufcturing fir nd thus the ount of lor used in roducing ech unit of outut re not ffected y n increse in the wge rte in the nufcturing sector. The following roosition studies the ict of chnge in the endowent of citl of this country. Proosition : An increse in the endowent of citl leds nufcturing firs to choose ore dvnced technologies. The level of eloyent nd the eloyent rte in the nufcturing sector do not chnge. Proof: An liction of Crer s rule on the syste () leds to dn dk 3 / K e. 4

16 f n Plugging equtions () nd () into eqution (9) leds to h K h ( h) Kf. Plugging this vlue of f into eqution (), the level of eloyent in the nufcturing sector is not ffected y the ount of citl stock. Fro eqution (), the eloyent rte is thus not ffected y the ount of citl stock. When there is n increse in the ount of citl, rt of the citl is sored in the finncil sector nd the reining is sored in the nufcturing sector. The intuition ehind Proosition is s follows. Fro eqution (7), the nuer of nufcturing firs increses when the ount of citl increses. Fro eqution (8), n increse in the nuer of nufcturing firs leds to decrese in the rtio etween the rice of nufctured good nd the rginl cost if the level of nufcturing technology does not chnge. This leds to decrese in the rofit for ech unit of outut. To rek even, nufcturing fir roduces higher level of outut. The higher level of outut leds nufcturing fir to dot ore dvnced technology ecuse the higher fixed cost ssocited with ore dvnced technology cn e sred to higher level of outut. A chnge in the ount of citl does not ffect the level nd rte of eloyent in the nufcturing sector. The reson is s follows. When the ount of citl increses, there re two effects ffecting the dend for lor in the nufcturing sector working in oosite directions. First, ecuse nufcturing firs choose ore dvnced technologies, the dend for lor for ech unit of outut decreses. Second, ecuse n increse in the ount of citl increses fctor of roduction nd citl is fully eloyed, this leds to n increse in the level of outut nd increses the dend for lor in the nufcturing sector. With the secifictions of costs in equtions () nd (), the two effects cncel out ech other. As result, the level nd rte of eloyent in the urn sector is not ffected y the ount of citl. In the next three sections, we will study the ict of econoic integrtion. For trctility, we ssue tht the two countries re identicl in ll sects. riles ssocited with the foreign country crry n sterisk rk. First, we study finncil integrtion without trde integrtion etween the two countries. Second, we exine trde integrtion without finncil integrtion etween the two countries. Third, we ddress joint finncil nd trde integrtion etween the two countries. 5

17 3. Finncil integrtion etween the countries In this section, we study the ict of finncil integrtion ut no trde integrtion etween the two countries. Under finncil integrtion, the rkets for citl in the two countries re integrted. As result, the interest rte id to deositors nd the interest rte chrged y nks will e the se in the two countries. Under finncil integrtion, nk coetes with oth doestic nd foreign nks. As result, eqution (6) feturing nk s otil choice of the level of outut is relced with h R r. (6f) ( *) Under finncil integrtion, the totl ount of citl used y the nufcturing sector in the two countries is equl to the totl suly of citl rovided y the finncil sector in the two countries. As result, eqution (8) feturing the equiliriu for the rket of citl in the nufcturing sector is relced with ( f * f *) d ( x * x*) d. (8f) Under finncil integrtion, the ount of citl eloyed in the finncil nd nufcturing sectors is equl to world suly of citl. As result, eqution (9) is relced with ( f * f *) d ( f * f *) d K K *. (9f) Since the two countries re identicl in ll sects, we focus on syetric equiliriu in which the vriles in the two countries tke the se vlue. In syetric equiliriu with finncil integrtion, equtions (3)-(5), (6f), (7), (8f), (9f), nd ()-(5) for syste of 3 equtions defining 3 endogenous vriles e,,, 6, q, r,,,, n, R, x, nd x s functions of exogenous reters. An equiliriu with finncil integrtion is tule ( e,,,, q, r,,,, n, R, x, x ) stisfying equtions (3)-(5), (6f), (7), (8f), (9f), nd ()-(5). Siilr to the equiliriu in utrky, the syste of 3 equtions cn e reduced to the following syste of three equtions defining three endogenous vriles n, functions of exogenous reters:, nd e s ( h) Kf ' ' ' f f K, (3)

18 ( h) Kf ( ) /( ) f K ( ) ( ), (4) e w ( ) T ( ). (5) For corison etween the equiliriu with finncil integrtion nd the equiliriu under utrky, we cn rewrite equtions (3)-(5) s follows: ( ) ' ' ' h Kf f f K, (6) ( ) ( ) h Kf /( ) f K ( ) ( ), (7) e w ( ) T ( ). (8) 3 For equtions (6)-(8), if, then they re the se s equtions (3)-(5). A corison of equtions (9)-() with equtions (6)-(8) revels tht strting fro utrky, the ict of finncil integrtion cn e ctured y chnge in the vlue of fro one to two. With this in ind, rtil differentition of equtions (6)-(8) with resect to n, leds to, e, nd n n 3 dn d de 3 e d. (9) The deterinnt of the coefficient trix of endogenous vriles in syste (9) is n 3 F 3 e F :. Prtil differentition of equtions (6)-(8) yields,, nd e n. Thus F. With F nonsingulr, unique equiliriu exists for the syste (9). The following roosition studies the ict of finncil integrtion on the level nd rte of eloyent in the nufcturing sector nd the level of nufcturing technology. 7

19 Proosition 3: Cored with utrky, finncil integrtion does not chnge the level nd the rte of eloyent in the nufcturing sector. Mnufcturing firs dot ore dvnced technologies. Proof: An liction of Crer s rule on (9) leds to d d, de d, dn 3 d e / F. Fro equtions (6f), (7), (8f), nd (9f), the nuer of nks in country with finncil integrtion is ( h) K f. To understnd Proosition 3, with finncil integrtion, even though the totl nuer of nks in the two countries is higher thn the nuer of nks in country in utrky, in ech country soe nks will exit fter finncil integrtion. 3 Since nk uses citl s fixed costs of roduction, this exit of soe nks releses citl fro the finncil sector nd thus increses the suly of citl to the nufcturing sector. As result, nufcturing firs choose ore dvnced technologies. Finncil integrtion does not ffect the level nd rte of eloyent in the nufcturing sector. With finncil integrtion, there re two effects ffecting the dend for lor in the nufcturing sector working in oosite directions. First, for ech unit of outut, with ore dvnced technology, the dend for lor decreses. Second, the level of outut increses nd the dend for lor increses. With the secifiction of technologies in equtions () nd (), the two effects cncel out ech other nd thus finncil integrtion does not chnge the level nd rte of eloyent in the nufcturing sector in ech country. 4. Trde integrtion etween the two countries 3 The exit of nks in this odel of oligooly is siilr to the exit of firs in odel of onoolistic coetition. Since ech fir roduces one vriety under onoolistic coetition, the nuer of firs is equl to the nuer of vrieties. With the oening u of interntionl trde, the totl nuer of vrieties for the world s whole is lrger thn the nuer of vrieties in ech country efore trde. However, fter the oening u of interntionl trde, soe firs will exit in ech country nd thus the nuer of vrieties in given country will decrese. 8

20 In this section, we ddress the ict of trde integrtion ut no finncil integrtion etween the two countries. We ssue tht there is no cross the order trnsorttion costs for the griculturl good nd nufctured goods. As result of trde integrtion, rices of the griculturl good nd nufctured goods will e equl in the two countries. With trde integrtion etween the two countries, nufcturing fir coetes with oth doestic nd foreign nufcturing firs. As result, eqution (3) feturing nufcturing fir s otil choice of outut is relced with w. (3t) * Since rkets for the griculturl good in the two countries re integrted under trde integrtion, eqution (4) feturing the clernce of the rket for the griculturl good is relced with ( T T * ) ( ew e* w * r K r * K * qt q * T*). (4t) Since rkets for nufctured goods in the two countries re integrted under trde integrtion, eqution (5) feturing the clernce of the rket for nufctured goods is relced with ( x * x*) d ( )( ew ew * r K r * K * qt q * T*). (5t) We focus on syetric equiliriu in which the vriles in the two countries tke the se vlue. In syetric equiliriu with trde integrtion, equtions (3t), (4)-(3), (4t), nd (5t) for syste of 3 equtions defining 3 endogenous vriles e,,,, q, r,,,, n, R, x, nd x s functions of exogenous reters. An equiliriu with trde integrtion is tule ( e,,, (4)-(3), (4t), nd (5t)., q, r,,,, n, R, x, x ) stisfying equtions (3t), In syetric equiliriu, the syste of 3 equtions chrcterizing the equiliriu with trde integrtion cn e reduced to the following syste of three equtions defining three endogenous vriles n,, nd e s functions of exogenous reters: ( h) Kf ' ' ' f f K, (3) 9

21 ( h) Kf ( ) /[( )] f K ( ) ( ), (3) e w ( ) T ( ). (3) To fcilitte the corison etween the equiliriu with trde integrtion nd the equiliriu with utrky, we cn rewrite equtions (3)-(3) s follows: ( h) Kf ' ' ' f f K, (33) ( h) Kf ) /[ ( )] f K ( ) ( ), (34) ( e w ( ) T ( ). (35) 3 For equtions (33)-(35), if, then they re the se s equtions (3)-(3). A corison of equtions (9)-() with equtions (33)-(35) revels tht strting fro utrky the ict of trde integrtion cn e ctured y chnge in the vlue of fro one to two. With this in ind, rtil differentition of equtions (33)-(35) with resect to n, to, e, nd leds n n 3 e 3 dn d de d. (36) The deterinnt of the coefficient trix of endogenous vriles in syste (36) is n e 3 T nd 3 e (36). T :. Prtil differentition of equtions (33)-(35) yields,, n. Thus T. With T nonsingulr, unique equiliriu exists for the syste The following roosition studies the ict of trde integrtion on the level nd rte of eloyent in the nufcturing sector nd the level of nufcturing technology.

22 Proosition 4: Cored with utrky, trde integrtion does not chnge the level or the rte of eloyent. Mnufcturing firs choose ore dvnced technologies. Proof: An liction of Crer s rule on the syste (36) leds to d d, de d, dn d e 3 / T. With trde integrtion, in ech country the nuer of nks nd the level of outut of nk will not chnge. The intuition ehind Proosition 4 is s follows. With trde integrtion, higher degree of coetition in the rket for nufctured good leds to lower rofit rgin for ech unit of outut. To coenste for fixed costs of roduction, nufcturing fir roduces higher level of outut. A higher level of outut kes the dotion of ore dvnced technologies ore rofitle. Trde integrtion does not ffect the level nd rte of eloyent in the nufcturing sector. With trde integrtion, there re two effects ffecting the dend for lor in the nufcturing sector. First, the dend for lor for ech unit of outut decreses ecuse nufcturing fir chooses ore dvnced technology. Second, the level of outut of nufcturing fir increses nd the dend for lor increses. With the secifiction of technologies in equtions () nd (), the two effects cncel out ech other nd thus trde integrtion does not chnge the level nd rte of eloyent in the nufcturing sector in ech country. 5. Corehensive integrtion etween the two countries In this section, we exine the ict of joint trde nd finncil integrtion or corehensive integrtion etween the two countries. Under corehensive integrtion, rkets for citl nd finl goods re integrted in the two countries. 4 We focus on syetric 4 We thnk Zhiqi Chen for suggesting the usge of the ter corehensive integrtion.

23 equiliriu in which the vriles in the two countries tke the se vlue. In syetric equiliriu with corehensive integrtion, equtions (3t), (4)-(5), (6f), (7), (8f), (9f), ()-(3), (4t), nd (5t) for syste of 3 equtions defining 3 endogenous vriles e,,, q, r,,,, n, R, x, nd x s functions of exogenous reters. An equiliriu with corehensive integrtion is tule ( e,,,, q, r,, equtions (3t), (4)-(5), (6f), (7), (8f), (9f), ()-(3), (4t), nd (5t).,,, n, R, x, x ) stisfying The syste of 3 equtions cn e reduced to the following syste of three equtions defining three endogenous vriles n,, nd e s functions of exogenous reters: ( h) Kf ' ' ' f f K, (37) ( h) Kf ( ) /[( )] f K ( ) ( ), (38) e w ( ) T ( ). (39) To fcilitte corison, we cn rewrite equtions (37)-(39) s follows: ( ) ' ' ' h Kf f f K, (4) ( ) ( ) h Kf /[ ( )] f K ( ) ( ), (4) e w ( ) T ( ). (4) 3 For equtions (4)-(4), if nd, then they re the se s equtions (37)- (39). With this ind, rtil differentition of equtions (4)-(4) with resect to n,, e,, nd leds to n n 3 e 3 dn d de d d. (43)

24 The deterinnt of the coefficient trix of endogenous vriles in syste (43) is C : n e 3 C. Prtil differentition of equtions (4)-(4) yields,, n nd 3. As result, e C. With C nonsingulr, unique equiliriu exists for the syste (43). A corison of equtions (6)-(8) with equtions (4)-(4) revels the following. Strting fro finncil integrtion lone, the ict of corehensive integrtion cn e ctured y chnge in the vlue of fro one to two. The following roosition studies the ict of trde integrtion fter finncil integrtion etween the two countries. Proosition 5: Strting fro finncil integrtion lone, further trde integrtion will led nufcturing firs to dot ore dvnced technologies. Proof: An liction of Crer s rule on (43) leds to dn d e 3 / C. A corison of equtions (33)-(35) with equtions (4)-(4) revels the following. Strting fro trde integrtion lone, the ict of corehensive integrtion cn e ctured y chnge in the vlue of fro one to two. The following roosition studies the ict of finncil integrtion fter trde integrtion etween the two countries. Proosition 6: Strting fro trde integrtion lone, further finncil integrtion will led nufcturing firs to dot ore dvnced technologies. Proof: An liction of Crer s rule on (43) leds to dn d e 3 / C. While corehensive integrtion leds nufcturing firs to dot ore dvnced technologies, siilr to the cse of trde integrtion or finncil integrtion, it does not chnge the level nd the rte of eloyent in the nufcturing sector. 3

25 6. Conclusion In this er, we hve studied the ict of finncil nd trde integrtion ong develoing countries on the choice of technology nd the level nd rte of eloyent in the nufcturing sector in generl equiliriu odel. We hve estlished the following results. First, in closed econoy, n increse in the wge rte in the nufcturing sector chnges neither the level of technology nor the level of eloyent in the nufcturing sector. Second, either finncil integrtion or trde integrtion etween develoing countries leds nufcturing firs to choose ore dvnced technologies. While ore dvnced technology uses lower ount of lor in roducing ech unit of outut, interestingly, the level nd rte of eloyent in the nufcturing sector does not chnge under finncil or trde integrtion. Acknowledgeents: I thnk Zhiqi Chen nd nonyous referees for their insightful suggestions. I solely resonsile for ll reining errors. References Benciveng, lerie, nd Bruce Sith Uneloyent, igrtion, nd growth. Journl of Politicl Econoy 5, Brnder, Jes Strtegic Trde Policy, in Gene Grossn nd Kenneth Rogoff (Eds.), Hndook of Interntionl Econoics. olue 3, Asterd: North-Hollnd, Brecher, Richrd Miniu wge rtes nd the ure theory of interntionl trde. Qurterly Journl of Econoics 88, Brecher, Richrd, nd Zhiqi Chen.. Uneloyent of skilled nd unskilled lor in n oen econoy: interntionl trde, igrtion, nd outsourcing. Review of Interntionl Econoics 8,

26 Chndler, Alfred. 99. Scle nd Scoe: The Dynics of Industril Citlis. Cridge, MA: Hrvrd University Press. Cho, Chi-Chur, nd Eden Yu Trde lierliztion in oligoolistic coetition with uneloyent: generl equiliriu nlysis. Cndin Journl of Econoics 3, Dvidson, Crl, wrence Mrtin, nd Steven Mtusz Trde nd serch generted uneloyent. Journl of Interntionl Econoics 48, Dvidson, Crl, nd Steven Mtusz. 4. Interntionl Trde nd or Mrket: Theory, Evidence, nd Policy Ilictions. Klzoo, MI: Ujohn Institute for Eloyent Reserch. Dvidson, Crl, nd Steven Mtusz.. Interntionl Trde with Equiliriu Uneloyent. Princeton, NJ: Princeton University Press. Dvis, Donld, nd Jes Hrrign.. Good jos, d jos, nd trde lierliztion. Journl of Interntionl Econoics 84, Frnkel, Frncine. 5. Indi s Politicl Econoy: New York, NY: Oxford University Press. Gong, Binglin, nd Hiwen Zhou. 4. Finncil develoent, the choice of technology, nd cortive dvntge. Journl of Interntionl Trde nd Econoic Develoent 3, Hrris, John, nd Michel Todro. 97. Migrtion, uneloyent, nd develoent: twosector nlysis. Aericn Econoic Review 6, 6-4. Hufler, Andres, nd In Wooton.. Coetition for firs in n oligoolistic industry: the ict of econoic integrtion. Journl of Interntionl Econoics 8,

27 Heln, Elhnn, nd Oleg Itskhoki.. or rket rigidities, trde nd uneloyent. Review of Econoic Studies 77, -37. ne, Phili, nd Gin Mri Milesi-Ferretti. 8. The drivers of finncil gloliztion. Aericn Econoic Review Pers nd Proceedings 98, evinson, Mrc. 6. The Box: How the Shiing Continer Mde the World Sller nd the World Econoy Bigger. Princeton, NJ: Princeton University Press. Mrtin, Philie, nd Helene Rey.. Finncil integrtion nd sset returns. Euroen Econoic Review 44, Mrtin, Philie, nd Helene Rey. 4. Finncil suer-rkets: size tters for sset trde. Journl of Interntionl Econoics 64, McKinnon, Ronld The Order of Econoic ierliztion: Finncil Control in the Trnsition to Mrket Econoy. nd edition, Bltiore, MD: Johns Hokins University Press. Nery, P. J. 3. The rod less trveled: oligooly nd coetition olicy in generl equiliriu, in (R. Arnott, B. Greenwld, R. Knur nd B. Nleuff, eds.), Econoics for An Ierfect World: Essys in Honor of Joseh E. Stiglitz, , Cridge, MA: MIT Press. Nurkse, Rgnr Proles of Citl Fortion in Underdeveloed Countries. New York: Oxford University Press. Person, Scott, nd Willi Ingr. 98. Econoies of scle, doestic divergences, nd otentil gins fro econoic integrtion in Ghn nd the Ivory Cost. Journl of Politicl Econoy 88, Prendergst, Renee. 99. Scle of roduction nd choice of technique in the engineering industries in develoing countries. Journl of Develoent Studies 7,

28 Ruch, Jes Econoic develoent, urn undereloyent, nd incoe inequlity. Cndin Journl of Econoics 6, Slinger, Michel erticl ergers nd rket foreclosure. Qurterly Journl of Econoics 3, Sen, A. K. 96. Choice of Techniques. Oxford, UK: Bsic Blckwell. Shiro, Crl, nd Joseh Stiglitz Equiliriu uneloyent s worker disciline device. Aericn Econoic Review 74, Stewrt, Frnces Technology nd Underdeveloent. Boulder, CO: Westview Press. Turnovsky, Stehen Mcroeconoic Anlysis. New York, NY: Cridge University Press. Wen, ei, nd Hiwen Zhou.. Finncil nd roduct rket integrtion under incresing returns to scle. Estern Econoic Journl 38, Zhng, Jie.. Urniztion, oultion trnsition, nd growth. Oxford Econoic Pers 54, Zhng, Xioo, Jin Yng, nd Shenglin Wng.. Chin hs reched the ewis turning oint. Chin Econoic Review, Zhng, Junxi. 7. Endogenous rkus, intensity of coetition, nd ersistence of usiness cycles. Southern Econoic Journl 74, Zhou, Hiwen. 3. The choice of technology nd rurl-urn igrtion in econoic develoent. Frontiers of Econoics in Chin 8,