1. NS4540 Winter Term 2018 Labor Markets
Armendariz and Larrain Ch 11

2. Overview I
Area where reforms hardest to implement are labor markets and worker protection
Potential beneficiaries of deregulation are numerous, but
Generally poorer,
Unorganized, and
Informal sector workers
Potential losers often are more highly organized formal sector workers

3. Overview II
In particular case of privatization, excess employment in newly privatized firms had to be reduced to become competitive.
Hope was new private sector enterprises would
Absorb labor and
Labor would be protected.
However transition was economically and politically difficult, particularly in countries lacking safety nets.
Difficult also to move labor across industries.
In majority of cases the immediate effect of broad economic reforms was an increase in unemployment and informal employment.
However, some aid through severance payments, shares of privatized firms and early retirement schemes.

4. Background I
Latin American labor markets during ISI period – late 1940s to mid 1980s characterized by large rural to urban migration flows
These flows produced a highly segmented labor market
Harris Todaro model provides the theoretical framework
Model assumes labor unions and minimum wages keep urban wages considerably above market clearing wages.
Model explains given urban-rural wage differentials and the probability of getting a urban formal sector job the decision to:
Migrate
Remain unemployed in the formal sector
Eventually take up employment in the informal sector

5. Background II During the ISI period
Pace of urbanization in Latin America extremely high
Agricultural producers penalized to promote industrial growth
Between 1950 and 2000
In Asia the number of people living in urban areas increased from 17.4% to 36.7%
While in Latin America there figures were 41.4% to 75.3%
As labor quickly moved from rural to urban areas on expectations of higher wages, large number did not find jobs in the formal sector
Overvalued exchange rate and low interest rates caused firms to use more capital and less labor

6. Background III
Because agriculture offered very low wages, migrants often stayed in urban areas rather than returning
Created a pool of informally employed workers
As the pool increased the expected wage for informal workers fell
In equilibrium migration would stop because the expected wage in rural areas equalized the expected urban wage
The pool of informally employed individuals has increased in post-ISI Latin America.
At the same time, unions have lost power
One explanation for this development is trade liberalization

7. Background IV Trade liberalization argument
During the 1990s, a relatively small proportion of highly-skilled labor became employed in firms exposed to foreign competition
Simultaneously the vast majority of unskilled labor confined to informal self-employment and micro-enterprises producing for the domestic market
This made income inequality worse
Premiums of the skilled and formally employers grew
Earnings in the informal sector either remained stagnant or grew at a considerably slower pace
Large pool of unprotected workers triggered widespread discontent and political unrest as trade liberalization policies took hold

8. Background V
On other hand empirical evidence on the casual impact of trade openness on informality suggests small effects.
However many studies have suggested it is not trade liberalization but excessive labor protection policies that are at the root of the problem
Situation reflects trade-off between equity and efficiency
The Latin American workforce, formally employed under ISI lacked the skills to compete with Asian exporters
Formal sector employees were generally politized, especially under populist regimes
This led to exceedingly powerful labor unions especially in SOEs

9. Background V
Problem: Although the loss of efficiency could have been justified on the grounds of equity, in practice it was not.
At same time in most Latin American ISI countries labor productivity lagged behind real wages
Suggests labor protection of formal sector employees discouraged firms from hiring more labor
Implications:
Led to expanding informal sector
While unions lost much of their power, workers in the public sector remained heavily unionized
Process suggests reconciling efficiency gains from privatization and trade liberalization with equity requires massive amounts of investments in education and training for the majority of the Latin American workforce

10. Dynamics I
Many Latin American countries entered the 2000s with segmented labor markets
Minority of high-skilled labor employed in the new and competitive private sector and
A vast majority of unskilled labor employed in micro-enterprises and self-employed activities
Formal employment has been protected via
Regulation,
Labor laws to incentivize unionization and
Social security coverage
While formal employment increased after 2004 it was mostly because of higher rates of overall-growth

11. Dynamics II Obstacles to further formal sector absorption include
An unfriendly private business environment
Crime and corruption and
Lack of incentives to join the formal sector – micro enterprises prefer to avoid taxes by remaining informal
Fiscal constraints have created a vicious circle in which
Low levels of investment in training discourage unskilled labor from acquiring skills because private education is unaffordable
Concerns from the growing middle class have triggered political unrest in some regions