Do Rigidities in Employment Protection Stifle Entry into Export Markets?

Editor's Note: Murat Seker recently presented the findings of the paper discussed in the following blog post at a session of the FPD Academy. Please see the FPD Academy page on the All About Finance blog for more information on this monthly World Bank event series.

Many studies point to the importance of firms that export to economic growth and development. These firms tend to be larger, more productive, and grow faster than non-exporting firms. These findings have focused policymakers’ attention on the importance of international trade for economic growth. From the 1980s to the 2000s traditional trade policies have improved significantly—applied tariff rates across a wide range of countries with varying levels of income have decreased from around 25 percent to 10 percent. However, improvements in trade policies are often not enough to reap the full benefits of international trade. To be fully effective, they require complementary reforms that improve the business environment for firms. In a recent paper on Rigidities in Employment Protection and Exporting, I focus on a particular aspect of the business environment, namely employment protection legislation (EPL), and show how these regulations relate to the decisions of firms to enter export markets.¹

Evidence shows that export market entry is associated with significant changes and adjustments in firm performance around the time at which exporting begins. In data collected via the Enterprise Surveys project, the employment levels of firms that subsequently enter export markets ("future-exporters") grow by 13%, four times higher than the growth rate of firms that don’t enter export markets.² Bernard and Jensen (1999) find that the growth premium for these future-exporters as compared to non-exporters in the U.S. is 1.4% per year for employment and 2.4% for shipments.

In my own analysis, I find that firms that face difficulties in creating new jobs due to rigid EPL are less likely to participate in export markets. Stringent legislation raises the opportunity costs of hiring new workers. The higher costs decrease the competitiveness of firms, and this in turn leads to lower rates of participation in export markets.

In the analysis I use data from firm-level surveys conducted in 26 countries in Eastern Europe and Central Asia region in 2002 and 2005. Using one of the survey questions, I calculate the difference between actual and desired employment levels that stems from frictions caused by EPL. I then aggregate this change in employment level at the 2-digit sector level to find the desired net job creation rate in each of the six major sectors, e.g. manufacturing, wholesale, retail, and construction. The econometric analysis shows that firms are less likely to export in sectors where they are more discouraged in creating new jobs. In general, a 1 percent underemployment of workers in a sector caused by stringent EPL leads to a 16 percent decrease in the probability of exporting. When the same analysis is performed for 2-digit industries in the manufacturing sector rather than across sectors, a similar yet more significant relationship emerges.

The rigidities in the labor market also distort the export performance of firms already operating in export markets. Firms that are more severely affected by the regulations export less intensively. A 1 percent underemployment of workers decreases the export intensities of trading firms by more than 20 percent.

A firm’s export decision can be affected by the characteristics of the firm, sector or industry that the firm belongs to, macroeconomic environment, trade policies, or inefficiencies in the business environment. I have tested whether these factors affect the negative relationship between labor regulations and exporting. The results hold up even after these additional controls are included. 

For policymakers, the message is subtle but important. Eliminating trade barriers alone may very well not yield the hoped-for gains from trade. Rather, complementary reforms that improve the business environment may also be necessary to reap the full gains from trade. Although labor regulations are established to protect workers and increase aggregate welfare, they can have negative effects on the amount of labor demanded by firms. Policymakers need to consider the trade-offs between the effect of regulations on a wide range of economic outcomes. Although the link between labor regulations and exporting may not be obvious, stringent regulations can carry a high cost in the form of negative consequences for job growth, entry into export markets, and overall economic development.

References:

Seker, Murat (2010), “Rigidities in Employment Protection and Exporting,” World Bank Policy Research Working Paper Series No. 5303.

Bernard, Andrew B. and J. Bradford Jensen, (1999), “Exceptional Exporter Performance: Cause, Effect or Both?” Journal of International Economics, 47(1), pp. 1-25.

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¹ Within the rules and regulations set for governing the employment relationship between workers and firms, those that focus on the hiring and firing of workers are often referred to as employment protection legislations.
² These future-exporters entered export markets within a time frame of up to three years before the date of the survey.