Labor Markets and Economic Development
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Labor Markets and Economic Development

Ravi Kanbur, Jan Svejnar, Ravi Kanbur, Jan Svejnar

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Labor Markets and Economic Development

Ravi Kanbur, Jan Svejnar, Ravi Kanbur, Jan Svejnar

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About This Book

As developing and transition economies enter the next phase of reforms, labor market issues increasingly come to the fore. With the increased competition from globalization, the discussion is shifting to the need for greater labor market flexibility and the creation of "good" jobs. Moreover, the greater actual and perceived insecurity in labor markets has generated a new agenda on how to structure safety nets and labor market regulation. The older questions of the links between the formal and informal labor market, reappear with new dimensions and significance. More generally, it is clear that an accurate understanding of how labor market structures function is essential if we are to analyze alternative policy proposals in the wake of these concerns.

Oddly enough, in spite of this great importance, there are no recent monographs that bring together rigorous studies produced by academic researchers on these various issues. This book fills that gap. Under the steely editorship of Ravi Kanbur and Jan Svejnar, the contributors flourish in their attempts to enliven these debates.

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Publisher
Routledge
Year
2009
ISBN
9781135969370
Edition
1

1 Overview*

Ravi Kanbur and Jan Svejnar
As developing and transition economies enter the next phase of reforms, labor market issues increasingly come to the fore. With the increased competition from globalization, the discussion is shifting to the need for greater labor market flexibility, appropriate labor market regulation, and the creation of “good” jobs. Moreover, the greater actual and perceived insecurity in labor markets has generated a new agenda on how to structure safety nets. The older questions about the nature and links between the formal and informal labor markets reappear with new dimensions and significance. In addition, it is clear that an accurate understanding of how labor markets function is essential if we are to analyze alternative policy proposals in the wake of these concerns.
With this background, Cornell University and the International Policy Center at the Gerald R. Ford School of Public Policy of the University of Michigan hosted a major international conference—“Labor Markets in Developing and Transition Economies: Emerging Policy and Analytical Issues”—on May 25–7, 2007, at the Ford School in Ann Arbor, Michigan. The authors served as organizers of the conference, as well as editors of the present volume. This book presents theoretical, empirical, and policy chapters, most of which consist of revised papers that were presented at the conference. This overview provides the reader with a brief sketch of the arguments and findings of the chapters. The volume is divided into four parts: (I) Employment, Poverty, and Labor Market Dynamics, (II) Formality, Informality, and Labor Market Regulation, (III) Trade and Labor, and (IV) Human Capital, Productivity, and Gender.
Part I of the book focuses on labor market dynamics, including issues of employment growth and poverty, multiple job holding, race discrimination, biases introduced by attrition in labor force surveys, labor productivity growth and capital mobility, and the role of internal versus external labor markets in wage determination. The findings in this part of the volume suggest that policy makers ought to focus on: the interplay between principal sectors (e.g. agriculture and non-agriculture) when addressing the interplay of growth, employment, productivity, and poverty; the effects of rising wages and shifts in producer and consumer prices (the domestic real exchange rate) on employment; the relationship between the nature of the retirement system and informality as informal work appears to serve as a direct substitute for a pension system; the racial/ethnic component to the young people's success in finding work, and the extent to which quality of schooling differs across racial/ethnic groups. Finally, since micro data are increasingly used to inform policy, the findings in this part of the book strongly suggest that attention be paid to issues such as attrition in labor force and household surveys since, in the absence of careful treatment of these issues, the resulting estimates of policy effects may be biased.
Gutierrez, Paci, Orecchia, and Serneels note that many studies have detected a positive association between overall economic growth and poverty alleviation and that a new consensus is emerging that an important transmission channel between growth and poverty is the impact of growth on the employment opportunities of the poor. They point out that these stylized facts have led analysts and policy makers to focus on “jobless growth” as a major challenge in the struggle to ensure that poor benefit from economic growth. They also stress that in many developing countries poverty is not associated with unemployment but with low returns to labor in existing activities. This leads the authors to examine what types of aggregate and sectoral productivity and employment growth result in greater or lesser poverty reduction. They use 1980–2004 data on 106 short growth spells in 39 developing countries to perform a series of regressions assessing and decomposing the link between poverty and growth at the aggregate and sectoral levels. Using their decomposition methodology, the authors support the basic hypothesis that growth is associated with a reduction in poverty and they find that in the aggregate, employment-intensive growth does not matter for poverty any more than productivity-intensive growth. At the sector level, however, the authors demonstrate that employment-intensive growth in the secondary sector is associated with poverty reduction, while in agriculture it is associated with poverty increase. Productivity-intensive growth in agriculture has a positive correlation with poverty reduction, but his phenomenon may also reflect a movement of people out of agriculture. The results imply that policy makers ought to move beyond aggregate figures and correlations and focus instead on the sectoral aspects of growth, employment, productivity, and poverty.
Dipak Mazumdar and Sandip Sarkar focus on the dynamic relationship between growth and employment in India. In particular, they examine the deteminants of relationship between overall employment and output growth—the “employment elasticity”—in the formal (organized) sector of Indian industrial firms before, during and after the reform of the Indian labor market. The authors show that this employment elasticity has varied dramatically across different policy periods, ranging from +0.99 in 1974–1980 to –1.39 in 1996–2001. They then examine the elasticity of employment with respect to (i) producer and consumer prices (the domestic real exchange rate), (ii) value added, and (iii) wages. They find that the most important variables affecting the overall employment elasticity are the wage-employment trade-off and the “price effect,” with the latter being at least partly exogenous. The authors discuss how these findings are consistent with capital and labor being treated as quasi-fixed factors by firms and what the implications are for the dynamics of factor markets in different sectors of the economy.
Thomas Dohmen, Hartmut Lehmann, and Mark Schaffer use unique personnel data to analyze wage determination and wage inequality inside a Russian firm during 1997–2002. The authors test the competing hypotheses that wages are determined by (a) institutional factors related to industrial relations and an internal labor market, or (b) interplay of conditions in local labor markets, labor market institutions and optimization. They find that local labor market conditions have a strong impact on wage-setting at the firm level and that remuneration is not determined by formal internal rules and a stable institutionalized structure of wages. In times of high labor turnover, the managers are willing to pay higher than average real wages to attract and retain workers. In addition, real wages fall substantially for employees who initially earned the highest rents. Overall, the authors show that market forces influence the wage policies of the firm and that considerations for a stable internal labor market are of less concern.
David Lam, Murray Leibbrandt, and Cecil Mlatsheni use a newly collected longitudinal youth data set, the Cape Area Panel Study, to examine the role of education in youth employment and unemployment. The authors start by providing data on the transitions from schooling to employment and unemployment, and note that after leaving the educational system, young people have difficulty making the transition from school to work. Moreover, whites are much more successful in attaining work than coloured South Africans who are in turn more successful than Africans. Racial differences are noticeable even before the young people finish school, with white and coloured youth being more likely to work during the years they are enrolled in school. The authors then model transitions to the work force using a probit model and find that schooling as well as ability, proxied by the literacy and numeracy exam, increase the probability of employment, as does being in good health and completing secondary education. The results clearly display a racial component to success in finding work and since the literacy and numeracy exams may also reflect quality of schooling, they raise the question of whether quality of schooling differs across the racial groups.
Insan Tunali examines attrition patterns in the Turkish Household Labor Force Survey (HLFS) from 2000 to 2002. Attrition is an important issue in that if it is related to labor force status of individuals, it may result in biases in labor market indicators. Using 12 rounds of quarterly household level data from the survey, Tunali finds that household attrition is likely to be affected by the labor market status of the head of household. In order to test for non-ignorable attrition, Tunali follows the model of Fitzgerald (1998) and performs the FGM and BGLW tests on a probit model in which the probability of attrition is dependent upon the labor force status of the household head, household characteristics, and the survey round. The model is estimated for every attrition interval (3, 12, 15 months) and Tunali finds that the probability of attrition is 8% in three months, 18.3% in 12 months, and 24.7% in 15 months. Based on these findings, Tunali suggests that indicators on transition dynamics be included among the information published on the basis of the HLFS.
The studies in Part II of the book examine issues of formality and informality of employment in the context of different market structures and regulations. In recent years, there has been an active debate about the extent and nature of the informal sector, but the debate has not resulted in a generally accepted definition or understanding of informality. Existing evidence suggests that tax and social security contributions, as well as government regulatory activities, are among the main causes of the existence of informal economy. Researchers hence usually take informality to imply non-participation or only partial participation of firms and workers in the tax and social security system, and their non-compliance or only partial compliance with regulatory requirements. For expositional clarity, it is useful to distinguish between two types of informal sector. The first type is a “fallback” sector in which individuals and firms end up as a result of not being able to survive in the formal sector. These firms and individuals could be market entrants that have not yet acquired the capabilities needed to compete in the formal sector, or they may be former participants in the formal sector that have not succeeded there. They are “rationed” into the fallback, informal sector by not being able to survive in the formal sector. They have low productivity and low wages, but are able to survive productively in the regulation- and tax-free informal sector. The second type of informal sector is an “optimizing” sector, which the participants select by choice because it gives them higher utility (combination of risk-adjusted income plus leisure). They move to the informal sector in response to disincentives associated with being in the formal sector. In this case, employers and/or employees are not rationed, but respond to incentives to avoid paying taxes and conforming to regulations. The reality is obviously a mixture of the two phenomena and the challenge for research and policy is to understand and determine the extent of each of them.
Ted To contributes to our understanding of informality by developing a theoretical model that provides a new explanation of the empirically observed phenomena that workers (a) often choose to work in the informal sector even if formal sector jobs are available to them at higher wages than jobs in the informal sector, and (b) willingly move between the two sectors in either direction. To's explanation consists of the formal and informal labor markets operating in the framework of oligopsony or monopolistic competition. He notes that the traditional competitive Harris-Todaro framework cannot be reconciled with workers locating voluntarily in the informal sector unless the formal and informal labor markets are fully integrated. In the competitive setting, full integration in turn implies equalization of the formal and informal sector wage rates, which is not corroborated by the evidence. To shows that oligopsony and monopsonistic competition models yield predictions that are consistent with the observed evidence and lend themselves to policy work. To also points to interesting areas for future research. One is to combine the oligopsony/monopolistic competition framework with that of Harris-Todaro to account for involuntary unemployment and/or location in the informal sector. Another is to account for wage spillovers across the sectors as a function of marginal products of labor varying with the number of establishments or total unemployment in each sector.
John Bennett and Saul Estrin link the issue of formality and informality with entrepreneurship. They develop a basic two-firm, two-period model of a developing economy with firm entry into industries that had previously not existed within the country. The profitability of introducing the technology for a new industry is uncertain. The model divides formal and informal firms by size and, as such, a profitable industry would prove more profitable in formality than informality. In the model, entrepreneurs use the informal market to test industry profitability, and, in some cases, the industry would never be established without the existence of the informal sector. Thus, the model implies that the informal sector may play an essential role in the growth of industries in a developing economy. They also consider how credit constraints may affect the pattern of entry.
Theis Theisen uses Tanzanian data to ascertain what determines whether individuals who work in the formal sector also participate in the informal labor market. This is the first estimation of a structural form participation function of multiple job-holding in developing countries. Theisen uses data gathered from 247 workers in five towns and 45 formal sector firms; these workers were asked questions regarding home production, underemployment, and informal work. Theisen performs four regressions: first, he estimates a structural-form multinomial logit model describing the allocation of workers in the formal sector; second, he estimates an earnings function for private sector formal workers; third, the estimated private sector earnings are used to estimate a “virtual wage rate” for all persons; and, finally, he estimates two different logit models to determine the decision to hold an informal sector job. The results indicate that income and the presence of children inversely affect participation in the informal sector, while informal sector participation is positively related to age and being female. The finding that income, being male, and the presence of small children have a negative effect on participation in a secondary job is similar to findings in the United States, while the positive effect of age is opposite to the US findings. Theisen argues that the differential effect of age in Tanzania and the USA is probably attributable to the superior retirement system in advanced economies such as in the USA. In particular, his explanation that informal work serves as a substitute for a pension system in Tanzania is plausible; while in the West, older workers retire from their second job as they age, Theisen's results indicate that older Tanzanians will take on a second job in their old age.
Mariano Bosch tackles the issue of formality versus informality in the context of a labor market search model, in which individuals decide whether to become workers or entrepreneurs on the basis of their managerial ability and the start-up costs associated with being in the formal sector. Formal entrepreneurs get to employ more productive workers but also face start up-costs (regulation). The informal sector entrepreneurs avoid these costs but work with a worse technology. Workers direct their search toward the formal or informal sector. More regulation expands the informal economy, but the effect on unemployment is unclear—the formal sector destroys jobs but also creates opportunities for both entrepreneurs and workers to shift into the informal sector. The net effect on unemployment depends on policy parameters such as the level of unemployment benefits, and attitudes and policies toward informality.
Santiago Levy uses institutional information, theoretical modeling, and data from Mexico to demonstrate that Mexican social programs are a source of informality and may lower growth and productivity by distorting the choices of firms and workers. The programs do so by segmenting the labor market through taxation of formal salaried workers and subsidies for informal and non-salary workers. Levy develops a model with salaried, self-employed, and non-salaried firm labor; firms may choose to be formal or informal. Formal firms, however, are required to pay social security benefits even though workers in both sectors receive social benefits. As a result, productivity is lowered and investment decisions are distorted. Levy argues that, in order to correct for these inefficiencies, Mexican social programs—and by implication similar programs in other countries—ought to be redesigned to ensure that formal and informal workers enjoy equal benefits and that the benefits are paid for with the same source of revenue.
Mabel Andalón and Carmen Pagés examine the performance of the minimum wage legislation in Kenya. The authors select coverage and enforcement, as well as the effect on wages and employment, as the criteria of performance of the minimum wage system. They use Kenya's 1998/9 Integrated Labor Force Survey, containing 11,040 households and 52,016 individuals, to find that the minimum wage was more strongly enforced and had stronger effects in non-agriculture than agriculture. Minimum wages are found to have a positive effect on the wages of women and low-educated workers in non-agricultural activities in urban areas, but not in agricultural activities. Furthermore, they resulted in a lower proportion of workers in formal employment. The authors suggest that the apparent non-compliance is a result of either the complexity of the minimum wage system, outdated job-wage classifications, or minimum wages being too high.
Errol D'Souza examines the trade-off between insurance and efficiency associated with job security regulations in India. He notes that while workers consider the trade-off between shirking and working, employers consider the trade-off between honoring a contract and terminating employment. D'Souza examines theoretical and empirical evidence related to the effect of job security regulation on the efficiency of the Indian labor market and concludes that although increased job security does increase rigidity in the labor market, it also allows workers to be insured efficiently in a manner which would not occur in an unregulated labor market. Employment protection may result in workers investing in a job and employers honoring contracts, but the challenge is how to achieve this without the “protection becoming protectionist.”
Sugata Marjit and Saibal Kar note that recent growth experience in India suggests that an important role is played by a skill-based service sector and productivity improvement rather than a rise in physical capital accumulation. In order to provide an understanding of this phenomenon, the authors develop a general equilibrium model dealing with labor productivity growth, informal wages, and capital mobility. The model has three sectors: one for skilled formal workers, one for unskilled formal workers, and a third one for unskilled informal workers. The goal of the analysis is to consider the role of an increase in the productivity of labor in the formal sector on the wage rate in the informal sector. The model predicts that in the short run improved productivity of skilled workers decreases informal sector wages, but that the effect is nil in the long run if capital is perfectly mobile across sectors. It also predicts that an increase in the productivity of unskilled workers in the formal sector may increase informal sector wages in the short run, but not in the long run, depending upon capital mobility. Finally, secular productivity growth in the informal sector may result in a lower wage of informal sector workers if capital mobility is restricted between the formal and informal sectors but not when there is full capital mobility. The analysis shows that capital mobility plays a crucial part and that measures such as further development of the financial sector may have a beneficial effect not only on the formal sector but on the informal sector as well.
Part III of the book examines the interplay of trade and labor issues. The chapters respond to the substantial general interest in this area, with key issues being whether labor regulation makes a country disadvantaged in trade, whether trade openness erodes labor standards, whether foreign firms pay higher wages than domestic firms, and whether trade reforms affect different groups of workers differently.
Yiagadeesen Samy and Vivek Dehejia start by presenting a review of the literature on the relationship between labor standards and trade. The authors then estimate a simple econometric model, using data from the ILOLEX database and other sources, with the log of manufacturing exports as a percentage of total GDP determined by the ratio of population to land, by literacy, and by labor standards. They find weak support for the notion that nations with lower labor standards hold an advantage in trade and no evidence that openness in trade encourages a worsening of labor standards. The authors suggest that future research focus on efficient methods to include labor...

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