Fitting Optimal Labour Market Institutions on Countries’ Plateau

The Internimagesational Labour Organisation (ILO) considers Labour Market Institutions (LMIs) as a system of laws, norms or conventions resulting from a collective choice and providing constraints and incentives that influence individual choices over labour and remuneration. It is referred to long term horizon and the main LMIs should include (Cazes and Verick, 2013):
• Minimum wages
• Collective bargaining and trade unions
• Unemployment and mandated benefits

Despite the fact that the Classical Labour Market Model considers the Labour Market as a perfect competitive with an equilibrium point between the supply and demand curve, there is a general consensus among researchers, practitioners, policy makers and other stakeholders that Labour Markets have some significant imperfections that may be addressed through the LMIs and the use of Active Labour Market Policies (ALMPs).

Key evidence on the impact of LMIs on employment
The impact of LMIs in the Labour Market is often the subject of heavy ideological debates among the parts (Freeman, 2011). However, the empirical evidence shows that the estimated effects of LMIs in the outcomes of the Labour Market are mainly modest or nulls (Betcherman, 2012). At the same time, the principle of caution should be considered if you are analising data due the multidimensionality and endogeneity of the LMIs.

The empirical evidence of the impact of EPL and Minimum wages take into account the dimensions of Living Standards, Productivity and Social Cohesion. The Indicators linked to these dimensions are Aggregate Employment/Unemployment, targeted groups, employment dynamics, adjustment to shocks, wage distribution, productivity growth, training, technological change, reallocation of labour, fairness, security, equality and poverty. This analytical approach presents mixed results but some clear evidences tend to arise above all:

• Minimum wages and EPL have a significant effect reducing poverty and narrowing earnings inequality. Not only is in the formal sector, but also in the informal one, due the lighthouse effect. However, stricter EPL and relative higher minimum wages may shift formal employment away from specific groups such as youngsters, women, disable people and the less skilled.

• EPL has an important effect in diminishing Labour Market flows and increasing the duration in employment and unemployment transitions. Furthermore, EPL has some positive effect on productivity in terms of training and investing in human capital.
Most countries are set on a ¨Plateau¨

Regulations always depend on country’s context but the results confirm the idea that many nations understand the risk of setting EPL and Minimum Wages at the strong or weak extremes. Allocating in a optimum range where impact on employment or productivity may is modest and avoiding high costs to the enterprises, the EPL tends to alleviate some market failures and the Minimum wages enhance the wealth redistribution. Then, the country is on a ¨Plateau¨.

PLATEAUTheoretical predictions and empirical evidence
Competitive Labour Markets predict that strong EPL or higher minimum wages creates unemployment (Cazes, 2013), underemployment and shift part of the production from the formal sector to the informal one.

However, the empirical evidence is not aligned with these models (Betcherman, 2014). The reasons that explain the divergence are:

• Governments, Enterprises and Union workers make adjustments when are facing changes in the labour demand but they are not only taking into account the price of labour.

• The Developing countries usually have difficulties to enforce EPL.

• The impact of regulations is not always the same for all workers due the high vulnerability of some specific groups such as youngsters, migrants, women and disabled people.

Plateau implications for labour market reforms
When a Government is preparing labour market reforms the policy challenge is to avoid extreme decisions because it increases the risk of pushing LMIs over the Plateau. Despite the fact that the Plateau is country specific and includes changes in terms of inter-temporal series, the consequences of being out of the Plateau are quite dramatic. It implies more inefficiency of the labour market, the failure tackling unemployment and also a significant increase of inequality among other non-desirable effects. A paradigmatic example of labour market reforms without considering the country Plateau is Spain.

Last but not least, another important implication of the Plateau is the redistributive effect of the labour market reforms which let partially address some imperfections. A realistic approach that take into account the country Plateau, uses Benchmarking tools and enforces the labour market reforms into other national reforms such as industry, energy, education and monetary policy may create the right conditions for an strengthened labour market.

Changing LMIs
The existence of a Plateau does not mean that countries should not change their LMIs because some imperfections may be addressed with punctual changes in the LMIs, but it should be taken into account the country specific profile and try to keep the country in the safe area of its Plateau. Furthermore, studies shows some effects in countries that have changed LMIs such as Germany with the Protection Against Dismissal Act (Verick, 2004) or the new forms of collective bargaining in China.

Countries falling off the cliffs
Empirical evidence in India or Colombia shows that the impact of changes on LMIs is more negative when the country has fallen off the cliff. Dramatic changes in labour regulations and minimum wages will produce important employment losses if the country is already in the edge or falling off. It does not mean that the solution is the lack of regulation or a passive institutional attitude. Probably, the effort should be focus on other risks less visible that are affecting negatively.

Implications of enforcement for countries placement on the Plateau
One successful key when a country is pursuing optimal LMIs is to develope a good enforcement of the regulations and a systematic culture of the compliance among the main actors. A Weak development of LMIs will affect negatively the country stability in the Plateau and will maintain unaddressed the imperfections of the Labour Market which means an increased probability of worsening the Labour Market outcomes.

To sum up, the design, execution, monitoring and evaluation of new LMIs should consider not only the country Plateau but also the empirical evidence of the labour market outcomes and pay attention on the culture of enforcement in order to increase the probabilities of success.

Betcherman, G. 2012. “Labor market institutions: a review of the literature”, World Bank Policy Research Working Paper, No. 6276.

Betcherman, G. 2014. “Designing labour market regulations in developing countries”, IZA World of Labor, No. 57.

Cazes, S. & Verick, S. (eds) 2013. Perspectives on Labour Economics for Development. ILO, Geneva.

Freeman, R. 2011 “New Roles for Unions and Collective Bargaining Post the Implosion of Wall Street Capitalism” Negotiating for Social Justice. ILO, Geneva.

Verick, S. 2004. “Designing Threshold Effects of Dismissal Protection Legislation in Germany”, IZA World of Labor, No. 991.


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