Promotion of the Tradable Goods Sector and Income Distribution

Abstract

In recent years, the acute foreign debt problem faced by several less developed countries has forcefully induced them, one way or another, to effect corrections in some key relative prices and, simultaneously, to reduce their overall spending. Institutions like the World Bank and the International Monetary Fund have mainly advocated to force those corrections by increasing the real rate of exchange resorting to (real) devaluations. But such a policy is known to have many by-products, some of them not socially appreciated. This paper focuses on one of those devaluation by-products, namely, the effect on income distribution and particularly, the impact on labor's real income. A formal model is developed for this purpose, where important features of LDCs (specially Latin American) are included: e.g. a tradeable sector where natural resources are a distinct factor, a non-tradeable sector which is labor specific, and wage indexation, beside the foreign debt constraint. This model is then used to analyze two alternative policies that would prevent labor's real income from decreasing, while not precluding a required increase in the trade balance. As it turns out in a simulation experiment with Chilean data, a wage indexation policy is a plausible alternative, rating better than an expansionary domestic credit policy in terms of its inflationary costs.