Karp, Larry and Paul, Thierry
Labor adjustment and gradual reform: when is commitment important?
Journal of International Economics, 46, (2), . (doi:10.1016/S0022-1996(97)00055-X).
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We analyze a model in which a government uses a second best policy to affect the reallocation of labor, following a change in relative prices. We consider two extreme cases, in which the government has either unlimited or negligible ability to commit to future actions. We discuss the factors that determine the importance of commitment ability and provide numerical examples. The degree of commitment ability can alter the equilibrium policy both quantitatively and qualitatively. In both extreme cases the dying sector is protected during the transition to a free market, in order to decrease the amount of unemployment.
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