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Excessive Employment Regulation Hinders Economic Development

A sticky issue all over the world, strict labor regulation typically has had unwanted side effects


June 17, 2004
Copyright © 2004 CARIBBEAN BUSINESS. All Rights Reserved.

As local legislators ponder a series of bills that will add more labor laws and regulations to an already over-regulated Puerto Rico labor market, they would do well to check the findings of the latest study on the subject.

"Doing Business in 2004: Understanding Regulation," a World Bank-commissioned study by economists Simeon Djankov and Caralee McLiesh on the determinants of private-sector development, reveals that although employment regulation may have been necessary to correct past failures in the labor market, it should be adapted according to the changes in circumstances, technology, and business organization.

Djankov and McLiesh studied the three main components of employment regulation in various jurisdictions around the world: flexibility of hiring (part-time and fixed-term contracts), conditions of employment (flexibility in work time requirements, mandatory payments, minimum wage), and flexibility of firing (grounds and procedures for dismissal, notice periods, and severance payments).

According to the report, although employment regulation tends to increase the tenure and wages of incumbent workers, too-strict regulatory intervention yields four negative results.

First, it limits job creation, as evidenced by a comparison between Portugal’s heavily regulated labor market and the less regulated U.S. market. With fewer new jobs created in Portugal, workers have had to remain in their jobs, even if they don’t enjoy them. In the U.S., on the other hand, new employment opportunities have increased by 150% since 1950.

A second negative of strict regulation is that it reduces the flexibility of the work force. Djankov and McLiesh noted that workers’ skills tend to become obsolete after long stretches of unemployment. They again point to Portugal, where unemployment duration is three times longer than in the U.S. and over twice as long as in Brazil and Spain (both heavily regulated).

A third concern is that flexible labor regulation is typically linked to higher research & development (R&D) investment in technology. Compared with businesses in advanced nations with rigid labor laws, industries in countries with more liberal labor laws have almost 30% higher investment in R&D.

One reason for this is that workers have a tendency to resist new technology, especially if they fear it will cost them their jobs. Another is that stricter regulations on firing may cause business managers to reorganize their production process to accommodate displaced workers, which could reduce their incentive to buy new technology.

The fourth negative element is that restrictions on hiring and firing could result in smaller firm size, leaving economies of scale in manufacturing and some services unexploited.

Djankov and McLiesh said all four of these effects–less job creation, longer unemployment spells and the related skill obsolescence of workers, less R&D investment, and smaller company size–might serve to reduce productivity growth.

Employment regulation was first implemented by many advanced nations after World War II, primarily to protect workers from exploitation, discrimination, and other apparent market failures. Many countries tightened the rules during the fallout of the 1973 oil embargo, particularly those regarding collective dismissals. Since 1990, most developed nations have continued to revise their employment regulation.

Doing Business in 2004--Indexes on Employment Regulation

Flexibility of hiring

China: 17

Czech: Republic 17

Namibia: 17

Nigeria: 17

Papua New Guinea: 17

Australia: 33

Canada: 33

Denmark: 33

Poland: 33

Uganda: 33

Brazil: 78

Chad: 78

Greece: 78

Guinea: 78

Thailand: 78

Venezuela, RB: 78

El Salvador: 81

Mexico: 81

Panama: 81

Taiwan (China): 81

Conditions of employment

Hong Kong (China): 22

Zimbabwe: 22

Denmark: 25

Malaysia: 26

Singapore: 26

United States: 29

South Africa: 36

Sweden: 39

Norway: 39

Kuwait: 40

Nicaragua: 90

Mongolia: 90

Paraguay: 90

Turkey: 91

Poland: 92

Hungary: 92

Ukraine: 93

Chad: 93

Rwanda: 94

Bolivia: 95

Flexibility of firing

Hong Kong (China): 1

Singapore: 1

Uruguay: 3

Papua New Guinea: 4

United States: 5

Japan: 9

United Kingdom: 9

Australia: 13

Austria: 14

Malaysia: 15

Brazil: 68

Panama: 68

Peru: 69

Ukraine: 69

Mexico: 70

Belarus: 71

Russian Federation: 71

Paraguay: 71

Portugal: 73

Angola: 74

Emloyment laws

Singapore: 20

United States: 22

Malaysia: 25

Denmark: 25

Papua New Guinea: 26

Hong Kong (China): 27

Zimbabwe: 27

United Kingdom: 28

Austria: 30

New Zealand: 32

Paraguay: 73

Peru: 73

Mozambique: 74

Venezuela, RB: 75

Belarus: 77

Mexico: 77

Angola: 78

Brazil: 78

Portugal: 79

Panama: 79

Note: Indexes range from 0 to 100, with higher values indicating more-rigid regulation. The employment-laws index is the average of the flexibility-of-hiring, conditions-of-employment, and flexibility-of-firing indexes.

Source: Doing Business database

This Caribbean Business article appears courtesy of Casiano Communications.
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