Regulating the labor market can be especially contentious. Interventions like job security rules and minimum wages not only highlight ideological differences about the role of government and the social contract between capital and labor, but they directly affect the livelihoods of people.
In the end, the challenge is to get the balance right between enabling decent working conditions and incomes for employees and allowing employers the flexibility to run their operations efficiently and at a reasonable cost. While politics cannot be eliminated, careful data-driven analysis can inform the policy process by illustrating the likely effects of different regulatory options on important social and economic outcomes. Decision-makers in high-income countries have access to an extensive and continually expanding body of research to guide their deliberations on regulating the labor market.
What about developing countries? There has not been as much analysis in these settings, but more and more research is now being carried out. The evidence we now have suggests that most developing countries set labor market rules in a zone where some protection is provided to covered workers without imposing major costs on firms or the economy. However, it should be noted that this is not always the case. Take minimum wages for example. There are several developing countries where the minimum wage is set above the average value-added per worker, so employers have a strong incentive to bypass the law. And there are others that have no minimum wage at all.
Furthermore, there are two unique considerations when thinking about labor market regulation in developing countries. One is that these policies, adopted from industrialized models, actually apply to a very small part of the employed workforce. In low-income countries like Ethiopia and Liberia, for examples, more than three-quarters of the working population is either self-employed or engaged in family work, so job security rules, minimum wages, and other regulations cannot be applied in any relevant way. The same point applies to middle-income countries: in Morocco, for example, only half of workers are in wage employment.
The other consideration is that, even in the more structured parts of developing country labor markets, compliance is a formidable challenge. Employers who would like to avoid the costs of complying with labor regulations and employees who would prefer to maximize their take-home pay can more easily work “off the books.” For example, in most developing countries, between a quarter and a half of wage-earners receive less than the statutory minimum wage. In part, this low compliance reflects weak enforcement capacity. The inspector-to-working population ratio in developing countries is often five to ten times lower (and sometimes even considerably worse) than in European countries. Moreover, this does not take into account the quality of enforcement when inspectors do monitor workplaces.
Ultimately, the biggest challenge in regulating labor markets in developing countries is what to do about the hundreds of millions of workers (or even more) who are beyond the reach of formal rules and protections. At one time, it was presumed that, with time, the industrialized country model of regulation would apply to more and more developing country labor markets. It is now clear, however, that this is happening extremely slowly, if at all. The vulnerabilities of so many workers in the developing world during the past 18 months have exposed how serious this situation is. So the priority for researchers and policymakers is to rethink regulations and policies so that they can truly reflect the diversity of labor markets in low- and middle-income countries.
© Gordon Betcherman
Read Gordon Betcherman’s IZA World of Labor article, “Designing labor market regulations in developing countries.”
Gordon Betcherman is Professor Emeritus of Economics at the University of Ottawa, Canada, and an IZA Research Fellow.
We recognize that IZA World of Labor articles may prompt discussion and possibly controversy. Opinion pieces, such as the one above, capture ideas and debates concisely, and anchor them with real-world examples. Opinions stated here do not necessarily reflect those of the IZA.