Macroeconomic adjustment with segmented labor markets

This paper analyzes the macroeconomic effects of fiscal and labor market policies in a developing economy with an informal sector and a heterogeneous work force. A permanent reduction in government spending on nontraded goods leads in the long run to a depreciation of the real exchange rate, a fall in the market-clearing wage for unskilled labor, an increase in output of traded goods, and a lower stock of net foreign assets. A permanent reduction in the minimum wage improves competitiveness, and expands the formal sector. The effect of changes in unemployment benefits are also analyzed. (C) 1999 Elsevier Science B.V. All rights reserved.