Turkey has undergone various structural transformations towards higher integration with the world economy since the 1980s. With this respect, economic priorities have been changed and new mechanisms have been take place with regards to new priorities. Whereas production of goods that could compete with the world markets has been increasing, in the meantime production for domestic markets loses its priority. This is due to some distributional consequences 0f economic integration. Economic resources are reallocated from import substituting sectors to export oriented sectors because of the importance given more to produce goods that could compete with world markets. Meanwhile, this situation leads to an increase in employment capacity and income generating process of export oriented sectors while import substituting sectors have been declining.
In this paper we divide all economic activities into two main sectors namely, tradable and nontradable sectors. Tradable sector have two main parts as exportable and importable goods. Since tradable sector is integrated to the world economy, it is influenced from the changing conditions of the world economy. Accordingly, the price conditions of the tradable sector are determined by the world markets and the government has no power on the price level of this sector. On the contrary, nontradable sectors are not stick to world economy as they produce goods for domestic markets and therefore government has power on this sector and could be able to implement separate (her own) income policies.
Reallocation of economic resources between two main sectors (namely, tradable and nontradable sectors) due to giving more importance to tradable sector is mostly in favor of that sector. Tradable and nontradable sectors exhibit some different features. For example, major characteristics of tradable sectors in developing countries are the presence of high productivity of production factors and the requirement of high skilled workers. Meanwhile, nontradable sectors need relatively low skill requirement and low productivity of production factors. The nontradable sectors have the capability of absorbing more labour than that of the tradable sector due to lower skill requirement. Despite of these differences, overall income policies imposed in both sectors show similar features in many countries.
Therefore, applying non-discriminating income policies may cause problems in the economy. Implementing these policies would not only reward the less productive sector with a wage beyond its productivity; and punish the productive one with a wage below its productivity but also would lead to a financial burden to the government. Mainly, since a government has much more power on nontradable sector than she has on the tradable sector (due to the locally determination of demand and supply condition), policies applied into economy mostly target on increasing the demand conditions of nontradable sector to cover the lower marginal productiveness of this sector. As changing the demand conditions of that sector is easier than the changing the conditions of total factor productivity, governments chose to apply income policies in which demand of nontradable sector is targeted. Moreover, other reason of not targeting the total factor productivity, it rely on the fact that total factor productivity could not be changed in the short run, it took a while to improve productivity, and therefore this is not mostly targeted in the income policies.
Many studies in the HOS literature develop their framework without any (tradable versus nontradable) sectoral distinction. That is one of the weak grounds of the HOS model. Needless to say, nontradable goods have a reasonable share of the overall market. In a real economy, the aggregate demand for nontradable goods not only leads to a decline in production of tradable goods, but also leads to an increase in labor demand for nontradable goods. Nevertheless, with a bi-sectoral framework with only tradable sectors, the model will have limited applicability in the real world in which nontradable sector is large and thus plays a crucial role. A trade model with nontradable sector is first provided by Meade (1956), Salter (1959) and Swan (1960). McDougall (1970) build up a trade model with nontradable goods based on the earlier work of Pearce (1961), Komiya (1967) and, his own work, McDougall (1965). Besides, Gonzalez-Soriano (1990) gives a brief summary about the classification procedure of dividing the economy into tradable and nontradable segments. In all these models production factors are assumed to mobile across sectors within each trading economy and immobile across sectors. Despite those works that especially concerned with the relationship between the nontradable sectors and real wages, we must say that none of them includes the effects of differences (in tradable and non tradable sectors) in terms of productivity and demand conditions.
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