1. Ten Propositions on Labor Market Rigidity Martin Rama The World Bank XVIII Meeting of Latin American Network of Central Bank and Finance Ministries Inter-American Development Bank April 9-10, 2003

2. Proposition 1: Labor market rigidity matters If not in the long run, at least in times of economic turbulence Countries with “rigid” labor markets experience bigger downturns in bad times and recover more slowly once the right policies are in place. But what is “rigidity”?

3. Proposition 2: It is not necessarily the labor code The number of ILO conventions ratified by a country is a proxy of the “thickness” of its labor code. But the number of ILO conventions ratified is not a good predictor of economic performance. The number of “core” conventions ratified does is not relevant either, making attempts to link trade and labor standards somewhat irrelevant.

4. Proposition 3: The source of the problem may not even be in the labor market Labor market disequilibria may result from: Bad regulation of labor markets Bad regulation of product markets Bad macroeconomic management Deregulating the labor market is not a substitute for fiscal and monetary discipline.

5. Proposition 4: Not all labor regulations are alike Microeconomic studies suggest that impacts vary across regulations and also across countries. Example: minimum wages are not an issue in most of Latin America, but Colombia could be an exception. Public sector employment, unionization (maybe) and severance pay (really?) are more likely to have real impacts.

6. Proposition 5: Looking at labor costs only is misleading Entrepreneurs look at the extra costs from labor regulations Workers look at the benefits from those regulations The arithmetic of regulations needs to be fully worked out. It involves the elasticity of labor demand and supply as well as the “value” attached to benefits. Workers often “pay” for their benefits

7. Proposition 6: Coverage is to a large extent endogenous Individuals can be self-employed or salaried Firms can be formal or informal, and can also choose between short-term and long-term contracts Many transitions between covered and uncovered jobs are voluntary Endogeneity reduces the adverse effects of distortions

8. Proposition 7: There is no one-size-fits-all labor policy For each labor market intervention, several alternatives can be considered Example: income support in the event of job loss: Public works or training allowances or severance pay or unemployment insurance or individual savings accounts These options differ in coverage and cost, and have different impacts on incentives and consumption smoothing

9. Proposition 8: Labor policies are not a powerful redistribution tool… On the surface, labor market interventions are associated with lower inequality But after controlling for other country characteristics they turn out to be irrelevant Only spending through social security reduces inequality Implication: mind the implications of social security reforms leading to lower coverage

10. Proposition 9: … but there are losers and winners from reforms While income distribution may not be affected, relatively small groups of workers may suffer Losers are usually not poor. They are concentrated in the public sector or in heavily regulated activities. They tend to be unionized and vocal. Designing appropriate compensation mechanisms can be key to the success of labor market (and product market!) reforms.

11. Proposition 10: There is scope for a multi-tier system Labeling by independent organizations is a substitute for traditional enforcement of labor regulations. By reducing transactions costs (including bribes) labeling could be in the interest of high-performing firms. From endogenous coverage to a “menu” of regulatory approaches Arguably, moving to the higher tier could be subsidized.