Trade Liberalization and Unemployment: Policy Issues and Evidence from Chile

How to liberalize? This is a question that has haunted policy makers and has confused policy advisors. A particularly pressing issue concerns adjustment costs associated with trade liberalization. This issue has been at the center of discussions about the proper sequencing and speed of reform.1 Does the order in which markets are reformed affect the outcome of the adjustment package? Should a country tackle the inflationary problem before dealing with market-oriented reforms, or should the opposite sequence be pursued? Which ‘order’ of liberalization will result in lower unemployment costs? Should the external sector be opened to foreign competition abruptly or gradually? How costly is trade liberalization if the labour market is still regulated and distorted? These questions are not only important from a purely economic point of view, but also from a political one. Often the sequence of reform will affect the political support for the reform process. While a particular sequence will generate support from certain groups — say exporters — it will alienate other groups, such as labour unions in protected sectors. In designing reform packages policy makers have increasingly tried to balance these political considerations with more technical ones.