Labor Market Flexibility and Economic Adjustment: A Cross-Regional and Cross-Country Analysis

This paper discusses the role of labor market flexibility in economic adjustment during the 1970s and the 1980s decades in developing countries in Asia, Latin America, the Middle East and Africa. In the first part of the paper it is argued that the success of the Asian countries to adjust to adverse external shocks during these two decades is by and large explained by their ability to develop a diversified export base with a high degree of specialization in manufacturing exports. We then introduce a new measure of real exchange rate as an index of manufacturing price competitiveness, and decompose this index into its wage cost and other components. It is shown that while manufacturing exports are highly responsive to the changes in relative export prices, there does not seem to be any links between the variations in manufacturing real exchange rates and relative export prices. Hence the absence of any relationship between manufacturing export performance and real exchange rates. We also observe no relationship between wage flexibility and manufacturing export performance. The different patterns of wage/employment outcome across the sample countries during the adjustment period calls for a broader definition of labor market flexibility which goes beyond wage flexibility highlighted in prevalent labor market models.