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Getting Labor Market Regulations Right

David Robalino's picture

Most countries regulate the way minimum wages are set, whether workers can be dismissed and how, and the type of compensation that employers have to pay. But many critics of these regulations contend that such policies undercut job creation. While it is understood that labor regulations are important to protect workers and create good jobs, questions regarding what is the right policy mix and how best to design and implement them remain a source of debate.

A construction worker finishes sealing glass, Kuala Lumpur, Malaysia. Photo credit: Flickr @World Bank Photo Collection

The most recent review of the research in the World Bank's 2013 World Development Report on Jobs shows that, in most cases, these regulations don't have much impact on employment. At the same time, not regulating labor markets at all can expose workers to abuse and inadequate working conditions. What does all this mean for policy makers? The answer appears to be first setting the right objectives for these regulations and then ensuring that they are appropriately designed.


Implications for Minimum Wages

Minimum wages can be useful, for instance, when labor markets aren't competitive and employers can impose wages that are too low — what economists call the extreme of labor market "under-regulation" as opposed to "over-regulation." In those cases, minimum wages not only don't reduce employment but they also can increase it, and as Gordon Betcherman (University of Ottawa) tells the JKP, both workers and society as a whole stand to benefit.

At the same time, minimum wages aren't the best instrument to fight poverty or guarantee a given standard of living. Other targeted transfers are likely to be more effective, particularly given that a majority of the poor don't benefit from minimum wages (see T. H. Gindling's IZA World of Labor note on "Does increasing the minimum wage reduce poverty in developing countries?"). Thus, if minimum wages are regulated, it's important to have the right process to set their level over time. One alternative is to rely on independent technical bodies that, at predetermined dates, study what the level of the minimum wage should be in consultations with the relevant stakeholders.


Implications for Regulations on Dismissal Procedures

It's also a good policy to protect workers from the risk of job loss. But making dismissals illegal or asking employers to receive authorization from a third party and pay compensation (severance pay) might not be the way to go — neither for workers nor employers (see my article with Michael Weber on why severance pay isn't an efficient mechanism to protect workers).

A better option is giving employers the needed flexibility to manage their human resources in response to business needs while making sure that workers have sufficient time to plan the transition to a new job and receive adequate financial support and access to quality employment services. In this case, employers can be mandated to provide adequate advance notice before a dismissal and contribute to a fund that is used to pay unemployment benefits, along with services such as job search assistance, counseling, and retraining. Governments at the same time need to be able to ensure the appropriate management of the fund and find the right service providers.

Some of these measures and other practical ideas are discussed in a short manual on labor regulations that the World Bank’s Labor and Youth Team is putting together in collaboration with the International Labour Organization (ILO) and the International Trade Unions Confederation (ITUC). The latter just posted a blog with a list of the worst places to have a job. You don't have to agree with the list but it's clear that in some cases the problem isn't "over-regulation" but the lack of it. And as Carmen Pagés (Inter-American Development Bank) reminds us, we should start to think more like medical doctors, whose guiding principle is to "first, do no harm," and think carefully about the impacts that changes in labor regulations have on labor markets. Both extremes — "under-regulation" and "over-regulation" — are likely to be welfare decreasing.

For more on this topic, see the upcoming JKP interviews with both Betcherman and Pagés and Betcherman"s IZA World of Labor policy note, "Designing labor market regulations in developing countries."

This post was first published on the Jobs Knowledge Platform.

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