A Ramsey model for a two-sector economy, comprising a labour intensive non-traded sector and a capital intensive traded sector, is used to analyse the transition following trade liberalization. Liberalization takes the form of removing a tariff wedge that benefited the non-traded sector. This increases overall productivity of capital in the short run, and demand for labour declines. In the presence of a binding minimum real wage this leads to transitional unemployment. In this case, gradualism - in the form of gradually removing the tariff wedge - can be justified. Through gradualism the protection for the labour intensive non-traded sector is prolonged, leading to reduced unemployment in the transition phase.
Economic reform, gradualism, two-sector economy, transition, unem-ployment
Research Council of Norway