Labor Market Institutions, Political Regimes, and Exchange Rate Policy in Developing Countries

Abstract

In this study, I argue that rigid labor market institutions (RLMIs) increase the likelihood of adopting fixed exchange rate regimes (FERRs) and lead to higher exchange rates in developing countries. Across the developing world, RLMIs render it imperative to fix exchange rates and facilitate its acceptance and implementation. Meanwhile, RLMIs contribute to domestic price overgrowth and consequently raise exchange rate levels in these places as well. Furthermore, such effects are posited to be stronger in developing democracies due to worker's political empowerment and regime-induced substitution. Empirical tests lend strong and robust support to these hypothesized correlations.