Cumulative Effects of Labor Market Distortions in a Developing Country.

This paper considers a small open economy where an input-output industrial structure, scale economies and imperfect competition, create vertical linkages and multiple equilibria. In this environment, an imperfect labor market is introduced by assuming unionized labor. It is shown that if the vertical linkages are sufficiently strong, a deregulation of the labor market may trigger a large, discontinuous expansion of industrial output, as reduced wage-costs start a circular, cumulative process in which the expansions of the up- and downstream industries promote each other.