Labor Regulations, Unions, and Social Protection in Developing Countries: Market distortions or Efficient Institutions?

Richard B. Freeman

NBER Working Paper No. 14789
Issued in March 2009
NBER Program(s):Labor Studies

This essay reviews what economists have learned about the impact of labor market institutions, defined broadly as government regulations and union activity on labor outcomes in developing countries. It finds that: 1) Labor institutions vary greatly among developing countries but less than they vary among advanced countries. Unions and collective bargaining are less important in developing than in advanced countries while government regulations are nominally as important. 2) Many developing countries compliance with minimum wage regulations produce spikes in wage distributions around the minimum in covered sectors. Most studies find modest adverse effects of the minimum on employment so that the minimum raises the total income of low paid labor. 3) In many countries minimum wages "spill-over" to the unregulated sector, producing spikes in the wage distributions there as well. 4) Employment protection regulations and related laws shift output and employment to informal sectors and reduce gross labor mobility. 5) Mandated benefits increase labor costs and reduce employment modestly while the costs of others are shifted largely to labor, with some variation among countries. 6) Contrary to the Harris-Todaro two sector model in which rural-urban migration adjust to produce a positive relation between unemployment and wages across regions and sectors, wages and unemployment are inversely related by the "wage curve". 7) Unions affect non-wage outcomes as well as wage outcomes. 8) Cross-country regressions yield inconclusive results on the impact of labor regulations on growth while studies of country adjustments to economic shocks, such as balance of payments problems, find no difference in the responses of countries by the strength of labor institutions. 9) Labor institution can be critical when countries experience great change, as in China's growth spurt and Argentina's preservation of social stability and democracy after its 2001-2002 economic collapse. Cooperative labor relations tend to produce better economic outcomes. 10) The informal sector increased its share of the work force in the developing world in the past two decades. The persistence of large informal sectors throughout the developing world, including countries with high rates of growth, puts a premium on increasing our knowledge of how informal sector labor markets work and finding institutions and policies to deliver social benefits to workers in that sector.

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Document Object Identifier (DOI): 10.3386/w14789

Published: Handbook of Development Economics Volume 5, 2010, Pages 4657–4702 Handbooks in Economics Cover image Chapter 70 – Labor Regulations, Unions, and Social Protection in Developing Countries: Market Distortions or Efficient Institutions?

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