1. The challenge of labour market regulation consists of alleviating market failures and providing protection to workers without imposing great costs on firms’ performance or economic efficiency. Although there has been a long and hot academic and political debate about labour market regulation (especially on employment protection legislation, EPL), different reviews suggest that the impacts are relatively small on aggregate and depends on the country context (Cazes et al., 2012). Nevertheless, labour regulation can have different impacts for different groups of workers. Minimum wage and EPL have an equalizing effect among covered workers, but for those not covered (mainly youth, women, and less skilled) the effects on their employment may be negative. Therefore, the modest aggregate effect on aggregate does not mean that labour market regulation does not matter (Betcherman, 2015). Although labour market regulations are introduced to correct market failures, they also have indirect costs for some groups of workers, and they must be minimized.
2. In order to produce a better regulation reforming national labour codes, the simplest approach consists of considering that any conceivable change can be implemented. However, labour law is a set of regulations with important complementarities across different norms. In addition, many of these complementarities are implicit rather than explicit. From this perspective labour market institutions are devices for expectations’ coordination of labour market actors (Deakin and Sarkar, 2008). These ‘devices’ or ‘institutions’ are never created ex-novo. They are always related to the previous political and legal legacy of the country. Then, labour market regulation does not only impose norms on economic agents, but also crystalizes social and legal practices drawn from the experience of labour market actors and, even, political actors (Deakin 2003; Deakin and Sarkar 2008). In addition, even countries with a common legal origin may develop substantial differences. The reason is the existence of unique events in specific countries creating path-dependence, even more when these unique events affect to the legal practice (Malo, 2005).
3. When considering the implementation of an important change in national labour law —what we usually call a labour market reform—, workers and employers will have to use the new set of institutions. They will have to adapt their behaviours to the incentives provided by the new regulation. However, because of the implicit complementarities between different labour market institutions the labour market reform may not have the expected results or even unexpected impacts. Therefore, understanding how the labour market reform will affect to the practice is crucial to design effective reforms.
In addition, any legal change introduces uncertainty until the new regulation is widely known by workers and employers, potentially creating conflicts or affecting employment or investments decisions by firms. Changes with agreement with the social partners usually created a lower level of uncertainty, because potential impacts of changes on workers and firms have been considered to reach the agreement. On the other hand, reforms unilaterally implemented by governments usually introduce more uncertainty, and decreasing conflicts interpreting new rules is slower.
4. Probably, the most debated field of labour market reforms is the EPL. The debate in developed economies lasts at least since the 1970s, when recommendations on increasing labour market flexibility widespread from some international organizations. This literature provided few evidence about huge effects of EPL on employment and unemployment rates, but a more convincing evidence about its impact on employment and unemployment flows (Haltiwnger et al., 2014; Messina and Vallanti, 2007). A less stringent EPL increased flows from employment to unemployment and vice versa. At the same time, some labour market reforms increased flexibility at the margin, i.e. for new entrants into the labour market, as in the case of temporary contracts, creating a sort of dual labour market (Saint-Paul, 1996).
In the 2000s, the focus moved towards developing economies. Djankov and Ramalho (2009) surveyed the literature on the effects of employment laws in developing economies. Roughly, in line with results from developed economies, Djankov and Ramalho (2009) found that countries with more stringent employment laws had a larger informal sector (as in the case of dual labour markets in developed economies) and higher unemployment, especially among young people. Feldmann (2009) also finds a negative impact on unemployment. However, Campos and Nugent (2012) find that changes in ‘rigidity’ do not systematically affect economic growth and do lower income inequality (as predicted by Freeman, 2010). It is difficult to see how both pieces of evidence might be complements, unless the expansion of the informal sector and the increase of unemployment are also linked with lower income inequality. Once again, the empirical evidence about the ‘rigidity’ of labour market regulation has important unsolved puzzles, also for developing economies. Adascalitei and Pignatti (2016) focus on labour market reforms related with the Great Recession, from 2008 to 2014. By contrast, respect to developed economies, in developing economies labour market reforms tended to increase workers’ protection. In addition, these authors find that neither increasing nor decreasing ‘rigidity’ of labour market regulation affects unemployment rates in the short-term. However, deregulatory labour market interventions have a negative short-term effect when implemented in times of crisis.
5. Previous literature has also analysed how changes in employment law in developing countries are related with a race to obtain foreign direct investment. Davies and Vadlamannati (2013) find evidence of competition in relaxing labour standards in both developed and developing countries, but the effect is strongest for developing countries with weaker standards. The impact of changes in one country on other countries is clearer in enforcement than in labour laws. This last result is disturbing, as the most part of analyses focuses on the wording on the law and not in the practice, closely linked with law enforcement. In a similar vein, Vadlamannati (2015) estimates the impact of globalization on changes in freedom of association and collective bargaining in developing countries. His results show a mixed evidence. While social globalization —i.e. connecting people along the globe— is associated with an improvement in laws and enforcement of freedom of association and collective bargaining rights, this is not the case for political globalization —i.e. political ties with other governments, international organizations, etc. In addition, the positive effect is sensitive to changes in the empirical analysis.
Therefore, we have two types of results: a stringer employment law is associated with a larger informal sector and, probably, more unemployment among some groups (as young people); and changing labour law to improve economic outcomes in a race with other countries to increase economic growth or attract foreign direct investment may weaken labour standards and workers’ rights. These results call for a cautious and counterbalanced approach to labour market reforms, weighting costs and benefits and not expecting miraculous results only changing the EPL. In addition, any change should attend to potential complementarities with other institutions of the labour market and, especially, to the enforcement of the law.
Adascalitei, D. and Pignatti, C. (2016) ‘Drivers and effects of labour market reforms: Evidence from a novel policy compendium’, IZA Journal of Labor Policy 5:15.
Cazes, S., Khatiwada, S., and Malo, M.Á. (2012) ‘Employment Protection and Collective Bargaining: Beyond the deregulation agenda’, Employment Working Paper 133, Economic and Labour Market Analysis Department, International Labour Organization, Switzerland: Geneva. Link: http://www.ilo.org/wcmsp5/groups/public/@ed_emp/documents/publication/wcms_191726.pdf
Betcherman, G. (2015) ‘Labor market regulations: What do we know about their Impacts in Developing Countries?’, World Bank Research Observer 30(1): 124-153.
Campos, N.F., and Nugent, J.B. (2012) ‘The Dynamics of the Regulation of Labor in Developing and Developed Countries since 1960’, William Davidson Institute Working Paper No. 1037.
Davies, R.B., and Vadlamannati, K.C. (2013) ‘A race to the bottom in labor standards? An empirical investigation’, Journal of Development Economics, 103, 1-14.
Deakin, S. (2003) ‘Evolution for our time: a theory of legal memetics’. Current Legal Problems 55: 1-42.
Deakin, S. and Sarkar, P. (2008) ‘Assessing the long-run impact of labour law systems: A theoretical reappraisal and analysis of new time series data’. Industrial Relations Journal 39:6, 453-487.
Djankov, S. and Ramalho, R. (2009) ‘Employment laws in developing countries,’ Journal of Comparative Economics 37(1), 3-13.
Feldmann, H. (2009) ‘The unemployment effects of labor regulation around the world’. Journal of Comparative Economics, 37, 76–90.
Freeman, R. (2010) ‘Labor regulations, unions, and social protection in developing countries: Market distortion or efficient institutions’, in D. Rodrik and M . Rosenzweig (eds.) Handbook of Development Economics, Vol. 5 (Elsevier): 4657-4702.
Haltiwanger, J., Scarpetta, S., and Schweiger, H. (2014). Cross country differences in job reallocation: The role of industry, firm size and regulations. Labour Economics, 26: 11–25. Link to the article: http://econweb.umd.edu/~haltiwan/LABOUR_HSS.pdf
Messina, J. and Vallanti. G. 2007. ‘Job Flow Dynamics and Firing Restrictions: Evidence from Europe’, Economic Journal, 117: F279-F301.
Saint-Paul, G. (1996) Dual Labor Markets. A Macroeconomic Perspective. Cambridge: MIT Press.
Vadlamannati, K.C. (2013) ‘Rewards of (dis)integration: Economic, social, and political globalization and freedom of association and collective bargaining rights of workers in developing countries’, International Labor Relations Review, 68(1), 3-27.
NOTE: This post is based in sections 2.4.1 and 2.4.2 of my working paper on labour market institutions in small Pacific island countries.
Malo, M.A. (2017): “Labour market institutions in small Pacific island countries. Main guidelines for labour market reforms”, MPRA Paper No. 79988. Link: https://ideas.repec.org/p/pra/mprapa/79988.html
This working paper was used as a basic source for the report prepared by the ILO Improving labour market outcomes in the Pacific: Policy challenges and priorities