Open-access Renewable Resources and Urban Unemployment: Dual Institutional Failures in a Small Open Economy

This paper investigates when poverty reduction and environmental resource preservation can be compatible in developing economies with two prominent institutional failures: wage rigidity in urban labor markets and open access to rural natural resources. We develop a small open dualistic economy model with these institutional features, and investigate the effects of an export tax on the resource good on urban unemployment and overexploitation of the rural resource. At the steady state, the first-best policy calls for an urban wage subsidy while rural labor should be subsidized at a lower rate, or be taxed. A rural tax constitutes the first-best policy when the domestic price of urban manufactured good is sufficiently high. Thus the well-known first-best policy prescription by Bhagwati and Srinivasan (1974) does not apply to developing countries when the world price of the resource good is low under free trade and/or an import tariff on the manufactured good is high. Unlike what the literature indicates, an increase in the export tax rate generally reduces the rate of urban unemployment, thereby improving welfare. However, the level of urban unemployment is more likely to increase if the initial rate of export tax is lower. A small export tax always improves welfare by mitigating the two institutional failures.