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The Effects of Foreign Transfers with a Flexible Labor Supply

Year 2012, Volume: 1 Issue: 1, 1 - 39, 01.02.2012

Abstract

We show that the importance of flexible labor supply in determining the impact of foreign transfers depends upon whether the transfers are untied or tied to productivity enhancement. This is because the transfer has both a wealth effect and a relative price effect, the relative importance of which depends upon its allocation. For an untied transfer, the relative price effect is weak, the wealth effect on leisure dominates, and the endogeneity of the labor supply is important. For a tied transfer, the increase in productivity raises the wage rate, thereby inducing an increase in aggregate labor supply and offsetting the increase in leisure due to the wealth effect. The overall response in leisure is small and is dominated by the relative price effect. In this case, given this small response, whether the aggregate labor is supplied elastically or is constrained to be fixed turns out to make little difference.

Thanks

This research is adapted from Chapter 3 of Serpil Bouza’s Ph.D. thesis written at the University of Washington. Serpil Bouza’s research was supported in part by a Buechel Fellowship, and Stephen Turnovsky’s in part by the Castor endowment, both at the University of Washington. The material presented here is related to a presentation by Turnovsky at the 2nd Turkish Economic Association Conference, Girne, North Cyprus, September 2010. The views expressed in this paper are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.

References

  • Arellano, C., A. Bulíř, T. Lane, and L. Lipschitz, (2009), “The Dynamic Implications of Foreign Aid and its Variability,” Journal of Development Economics, 88, pp. 87-102.
  • Balassa, B., (1964), “The Purchasing-Power Parity Doctrine: A Reappraisal,” Journal of Political Economy, 72, pp. 584-596.
  • Barro, R.J., (1990), “Government Spending in a Simple Model Of Endogenous Growth,” Journal of Political Economy, 98, pp. 103-125.
  • Brock, P.L., (1996), “International Transfers, the Relative Price Of Nontraded Goods and the Current Account,” Canadian Journal of Economics, 29, pp. 163-180.
  • Brock, P.L. and S J. Turnovsky, (1994), “The Dependent Economy Model With Traded and Nontraded Capital Goods,” Review of International Economics, 2, pp. 306-325.
  • Bruno, M. and J. Sachs, (1982), “Energy and Resource Allocation in a Small Open Economy,” Review of Economic Studies, 49, pp. 845-859.
  • Burnside, C. and D. Dollar, (2000), “Aid, Policies, and Growth,” American Economic Review, 90, p. 847-868.
  • Cerra, V., S. Tekin, and S.J. Turnovsky, (2009), “Foreign Transfers and Real Exchange Rate Adjustments in a Financially Constrained Dependent Economy,” Open Economies Review, 20, pp. 147-181.
  • Chatterjee, S., G. Sakoulis, and S.J. Turnovsky, (2003), “Unilateral Capital Transfers, Public Investment, and Economic Growth,” European Economic Review, 47, pp. 1077-1103.
  • Chatterjee, S., and S.J. Turnovsky, (2007), “Foreign Aid and Economic Growth: The Role of Flexible Labor Supply,” Journal of Development Economics, 84, pp. 507-533.
  • Corden, W.M., (1984), “Booming Sector and Dutch Disease Economics: Survey and Consolidation,” Oxford Economic Papers, 36, pp. 359-380.
  • Corden, W.M. and P.J. Neary, (1982), “Booming Sector and De- Industrialization in a Small Open Economy,” Economic Journal, 92, pp. 825-848.
  • Devarajan, S., D.S. Go, J. Page, S. Robinson, and K. Thierfelder, (2008), “Aid, Growth, and Real Exchange Rate Dynamics,” World Bank Policy Research Paper 4480.
  • Kang, J.S., A. Prati, and A. Rebucci, (2010), “Aid, Exports, and Growth: A Time Series Perspective on the Dutch Disease Hypothesis,” Inter- American Development Bank Working Paper No 29.
  • Keynes, J.M., (1929), “The German Transfer Problem,” Economic Journal, 39, pp. 1-7.
  • Kuralbayeva, K. and D. Vines, (2008), “Shocks to Terms of Trade and the Risk-Premium in an Intertemporal Model: The Dutch Disease and a Dutch Party,” Open Economies Review, 19, pp. 277-303.
  • Morshed, A.K.M. and S.J. Turnovsky, (2004), “Intersectoral Adjustment Costs and Real Exchange Rate Dynamics in a Two-Sector Dependent Economy Model,” Journal of International Economics, 62,pp. 147-177.
  • Morshed, A.K.M. and S.J. Turnovsky, (2006), “Elasticity of Substitution and The Persistence of the Deviation Of The Real Exchange Rates,” Review of Development Economics, 10,pp. 411-433.
  • Morshed, A.K.M. and S.J. Turnovsky, (2011), “Real Exchange Rate Dynamics: The Role of Elastic Labor Supply,” Journal of International Money and Finance (forthcoming).
  • Nkusu, M., (2004), “Aid and the Dutch Disease For Low-Income Countries: Informed Diagnoses for Prudent Prognoses,” IMF Working Paper 04/49.
  • Ohlin, B., (1929), “Transfer Difficulties, Real and Imagined,” Economic Journal, 39, pp. 172-178.
  • Pearce, I.F., (1961), “The Problem of the Balance of Payments,” International Economic Review, 2, pp. 1-28.
  • Rajan, R. and A. Subramanian, (2005), “Aid and Growth: What Does the Cross-Country Evidence Really Show?,” NBER Working Paper 11513.
  • Salter, W.E.G., (1959), “Internal and External Balance: The Role of Price And Expenditure Effects,” Economic Record, 35, pp. 226-238.
  • Samuelson, P.A., (1952), “The Transfer Problem and Transport Costs: The Terms of Trade When Impediments are Absent,” Economic Journal, 6, pp. 181-197.
  • Samuelson, P.A., (1954), “The Transfer Problem and Transport Costs: Analysis of Effects of Trade Impediments,” Economic Journal, 64, pp. 254-289.
  • Samuelson, P.A., (1964), “Theoretical Notes on Trade Problems,” Review of Economics and Statistics, 46, pp. 145-154.
  • Swan, T.W., (1960), “Economic Control in a Dependent Economy,” Economic Record, 36, pp. 51-66.
  • Tekin-Bouza, S. and S.J. Turnovsky, (2011), “The Distributional Consequences of Foreign Transfers: Do They Reduce or Exacerbate Inequality?,” Oxford Economic Papers (forthcoming).
  • Turnovsky, S.J., (1997), International Macroeconomic Dynamics, MIT Press, Cambridge MA.
  • Turnovsky, S.J. and P. Sen, (1995), “Investment in a Two-Sector Dependent Economy,” Journal of the Japanese and International Economies, 9, pp. 29-55.
  • Wijnbergen, S. van, (1985), “Optimal Capital Accumulation and the Allocation of Investment Between Traded and Non-Traded Sectors in Oil-Producing Countries,” Scandinavian Journal of Economics, 87, pp. 89-101.

The Effects of Foreign Transfers with a Flexible Labor Supply

Year 2012, Volume: 1 Issue: 1, 1 - 39, 01.02.2012

Abstract

We show that the importance of flexible labor supply in determining the impact of foreign transfers depends upon whether the transfers are untied or tied to productivity enhancement. This is because the transfer has both a wealth effect and a relative price effect, the relative importance of which depends upon its allocation. For an untied transfer, the relative price effect is weak, the wealth effect on leisure dominates, and the endogeneity of the labor supply is important. For a tied transfer, the increase in productivity raises the wage rate, thereby inducing an increase in aggregate labor supply and offsetting the increase in leisure due to the wealth effect. The overall response in leisure is small and is dominated by the relative price effect. In this case, given this small response, whether the aggregate labor is supplied elastically or is constrained to be fixed turns out to make little difference.

References

  • Arellano, C., A. Bulíř, T. Lane, and L. Lipschitz, (2009), “The Dynamic Implications of Foreign Aid and its Variability,” Journal of Development Economics, 88, pp. 87-102.
  • Balassa, B., (1964), “The Purchasing-Power Parity Doctrine: A Reappraisal,” Journal of Political Economy, 72, pp. 584-596.
  • Barro, R.J., (1990), “Government Spending in a Simple Model Of Endogenous Growth,” Journal of Political Economy, 98, pp. 103-125.
  • Brock, P.L., (1996), “International Transfers, the Relative Price Of Nontraded Goods and the Current Account,” Canadian Journal of Economics, 29, pp. 163-180.
  • Brock, P.L. and S J. Turnovsky, (1994), “The Dependent Economy Model With Traded and Nontraded Capital Goods,” Review of International Economics, 2, pp. 306-325.
  • Bruno, M. and J. Sachs, (1982), “Energy and Resource Allocation in a Small Open Economy,” Review of Economic Studies, 49, pp. 845-859.
  • Burnside, C. and D. Dollar, (2000), “Aid, Policies, and Growth,” American Economic Review, 90, p. 847-868.
  • Cerra, V., S. Tekin, and S.J. Turnovsky, (2009), “Foreign Transfers and Real Exchange Rate Adjustments in a Financially Constrained Dependent Economy,” Open Economies Review, 20, pp. 147-181.
  • Chatterjee, S., G. Sakoulis, and S.J. Turnovsky, (2003), “Unilateral Capital Transfers, Public Investment, and Economic Growth,” European Economic Review, 47, pp. 1077-1103.
  • Chatterjee, S., and S.J. Turnovsky, (2007), “Foreign Aid and Economic Growth: The Role of Flexible Labor Supply,” Journal of Development Economics, 84, pp. 507-533.
  • Corden, W.M., (1984), “Booming Sector and Dutch Disease Economics: Survey and Consolidation,” Oxford Economic Papers, 36, pp. 359-380.
  • Corden, W.M. and P.J. Neary, (1982), “Booming Sector and De- Industrialization in a Small Open Economy,” Economic Journal, 92, pp. 825-848.
  • Devarajan, S., D.S. Go, J. Page, S. Robinson, and K. Thierfelder, (2008), “Aid, Growth, and Real Exchange Rate Dynamics,” World Bank Policy Research Paper 4480.
  • Kang, J.S., A. Prati, and A. Rebucci, (2010), “Aid, Exports, and Growth: A Time Series Perspective on the Dutch Disease Hypothesis,” Inter- American Development Bank Working Paper No 29.
  • Keynes, J.M., (1929), “The German Transfer Problem,” Economic Journal, 39, pp. 1-7.
  • Kuralbayeva, K. and D. Vines, (2008), “Shocks to Terms of Trade and the Risk-Premium in an Intertemporal Model: The Dutch Disease and a Dutch Party,” Open Economies Review, 19, pp. 277-303.
  • Morshed, A.K.M. and S.J. Turnovsky, (2004), “Intersectoral Adjustment Costs and Real Exchange Rate Dynamics in a Two-Sector Dependent Economy Model,” Journal of International Economics, 62,pp. 147-177.
  • Morshed, A.K.M. and S.J. Turnovsky, (2006), “Elasticity of Substitution and The Persistence of the Deviation Of The Real Exchange Rates,” Review of Development Economics, 10,pp. 411-433.
  • Morshed, A.K.M. and S.J. Turnovsky, (2011), “Real Exchange Rate Dynamics: The Role of Elastic Labor Supply,” Journal of International Money and Finance (forthcoming).
  • Nkusu, M., (2004), “Aid and the Dutch Disease For Low-Income Countries: Informed Diagnoses for Prudent Prognoses,” IMF Working Paper 04/49.
  • Ohlin, B., (1929), “Transfer Difficulties, Real and Imagined,” Economic Journal, 39, pp. 172-178.
  • Pearce, I.F., (1961), “The Problem of the Balance of Payments,” International Economic Review, 2, pp. 1-28.
  • Rajan, R. and A. Subramanian, (2005), “Aid and Growth: What Does the Cross-Country Evidence Really Show?,” NBER Working Paper 11513.
  • Salter, W.E.G., (1959), “Internal and External Balance: The Role of Price And Expenditure Effects,” Economic Record, 35, pp. 226-238.
  • Samuelson, P.A., (1952), “The Transfer Problem and Transport Costs: The Terms of Trade When Impediments are Absent,” Economic Journal, 6, pp. 181-197.
  • Samuelson, P.A., (1954), “The Transfer Problem and Transport Costs: Analysis of Effects of Trade Impediments,” Economic Journal, 64, pp. 254-289.
  • Samuelson, P.A., (1964), “Theoretical Notes on Trade Problems,” Review of Economics and Statistics, 46, pp. 145-154.
  • Swan, T.W., (1960), “Economic Control in a Dependent Economy,” Economic Record, 36, pp. 51-66.
  • Tekin-Bouza, S. and S.J. Turnovsky, (2011), “The Distributional Consequences of Foreign Transfers: Do They Reduce or Exacerbate Inequality?,” Oxford Economic Papers (forthcoming).
  • Turnovsky, S.J., (1997), International Macroeconomic Dynamics, MIT Press, Cambridge MA.
  • Turnovsky, S.J. and P. Sen, (1995), “Investment in a Two-Sector Dependent Economy,” Journal of the Japanese and International Economies, 9, pp. 29-55.
  • Wijnbergen, S. van, (1985), “Optimal Capital Accumulation and the Allocation of Investment Between Traded and Non-Traded Sectors in Oil-Producing Countries,” Scandinavian Journal of Economics, 87, pp. 89-101.
There are 32 citations in total.

Details

Primary Language English
Subjects Economics
Journal Section Research Articles
Authors

Serpil Bouza This is me

Stephen J. Turnovsky This is me

Publication Date February 1, 2012
Published in Issue Year 2012 Volume: 1 Issue: 1

Cite

APA Bouza, S., & Turnovsky, S. J. (2012). The Effects of Foreign Transfers with a Flexible Labor Supply. Ekonomi-Tek, 1(1), 1-39.