benefit from trade by specializing in standardized commodities that use
abundant unskilled labour, but middle-income countries with
higher-skilled labour forces may exploit a wider range of options. In
Discussion Paper No. 862, Research Fellow Dani Rodrik considers a
small open economy that produces two tradable final goods under constant
returns to scale. The low-tech sector uses labour and capital, while the
high-tech sector also uses a range of differentiated, non-tradable
intermediates (producer services and specialized inputs), whose
production under increasing returns to scale requires skilled labour.
Rodrik identifies two possible equilibria. With initial specialization
concentrated in the low-tech sector, no single firm can profitably enter
the high-tech (or intermediate) sector at prevailing factor prices,
since sufficient demand for intermediates will exist only if enough
other firms already produce them. This coordination problem can be
overcome, however, by imposing a minimum wage which subsidizes the
incipient high-tech sector, thus promoting new entry that allows the
achievement of a superior equilibrium at a higher level of real income.
Maintaining a low-wage policy, in contrast, may crowd out potentially
viable medium- and high-tech sectors.
Rodrik relates his model to the transition in Eastern Europe, where many
countries that are well-endowed with human capital are maintaining cheap
currency policies and therefore risk attracting investment on the basis
of low labour costs instead. Eastern Germany, in contrast, should be
able to sustain Western levels of labour productivity in the longer
term, and its high current wages may draw resources into high-tech
industries that can utilize its educated and skilled labour force. East
Asian countries have also long recognized the potential trade-off
between low wages and industrial upgrading. Singapore, in particular,
has promoted high-tech industries by raising minimum wages and
discouraging immigration. Rodrik cautions, however, that the empirical
relevance of these ideas remains to be demonstrated.
Do Low-Income Countries Have a High-Wage Option?
Discussion Paper No. 862, January 1994 (IM)