The Effects of Increasing Openness and Integration to the Mercosur on the Uruguayan Labor Market : A CGE Modeling Analysis

Uruguay is a small economy. Its integration into MERCOSUR has increased its exposure to regional macroeconomic instability. The aim of this paper is to assess the impact of regional integration on the country's labor market and poverty. We estimated wage differentials between labor categories, finding a 60 percent wage gap between formal and informal workers. A CGE model with an efficiency wage specification for unskilled labor was built, with results showing that regional shocks deeply affect the Uruguayan economy. The consideration of an efficiency wage model is particularly important when shocks lead to a reallocation of resources towards sectors intensive in unskilled labor. A subsidy on formal, unskilled labor could contribute to decrease informality and therefore increase GDP, but this type of policy needs to be carefully implemented because it may have negative effects on investment. Finally, the effects on poverty and income distribution obtained through microsimulations are consistent with the results of the CGE experiments