All well-conducted structural reforms are alike; each badly conducted structural reform is badly conducted in its own way. There is a huge variety of structural reforms. They differ in terms of the areas they cover (contrast, say, privatisation with trade reform), their main drivers, and regarding the intensity and time-profile of their effects.
Labour market reform is one of the most important structural reforms but also one of the least well-understood. Labour reforms are often viewed as means to improve economic performance and increase welfare. Changes in employment laws that lower the costs of hiring workers (and of firing them) should foster job creation and help firms recover from shocks.
However labour reforms can also have negative effects on productivity, for example, if lower firing costs decrease the investments that firms make in human capital and on R&D.
The aggregate effects of employment protection regulation on economic growth and productivity are difficult to pinpoint. Some of the reasons for such difficulties are non-linearitites and implementation lags. Yet Freeman conjectures that, even if the effects of labour deregulation on growth and productivity are ambiguous, those on income inequality are not, with employment protection expected to stifle inequality.
Our knowledge about labour market reforms remains limited. This is because of a lingering dearth of adequate empirical measures. The existing measures and attendant econometric evidence, when not confined to rich OECD countries, are restricted to the years after 1990.
There remains a lack of measures covering both rich and poor countries that go back sufficiently in time so that one can study actual reforms, that is, changes in the levels of protection offered to workers by employment laws. Although labour laws change slowly over time, such changes have deep, widespread, and long-lasting implications. Increasing time and country coverage for these measures is essential for evaluating both the determinants and effects of changes in labour laws (i.e. labour market reform).
In our research, we construct a new de jure index of labour market regulations covering over 140 countries, both developed and developing, from 1950 to the eve of the Great Recession. We do so by quantifying the narrative information from the most comprehensive database of labour laws (Natlex) which is maintained by the International Labour Organization (ILO) and the US Department of Labor.
Using this new index, we first revisit the existing explanations for the rigidity of labour laws. Legal origin is by far the most widely accepted explanation. Countries with legal systems based on Common Law are said to have less protective labour regulations than those based on Civil Law. In other words, Civil Law (French) origin would generate labour laws that are more rigid, protective, all-encompassing and imposed in a top-down manner than those from Common Law (English) origin. Moreover, legal origins seem to provide a more powerful explanation than economic or political factors.
Using our new measure, we confirm that employment protection varies, across countries, significantly with legal origins. Indeed, support for legal origins with our larger sample of countries for the late 1990s is even stronger than in the seminal study.
However, moving from levels to rates of change (that is, once one focuses on reform proper) weakens the legal origins explanation. This led us to consider a wider range of reasons. For example, we evaluate the role of structural factors (such as share of agriculture in GDP, natural resources share in total exports, and inequality), other structural reforms (e.g., financial liberalisation and trade reform), crises (measured by the magnitude and extent of output and employment contractions), and political economy factors (such as political constraints, strikes, and violent political conflict.)
We find labour law rigidity is negatively associated with per capita income (richer countries tend to have more flexible labour laws) but positively related to trade reforms (countries that open up their economies follow up by increasing the rigidity of their employment protection laws.)
Our new index also strongly supports the Freeman conjecture that labour market rigidity reduces income inequality without adverse effects on growth. While this conjecture may be unsurprising to many, to the best of our knowledge, ours are the first results to evaluate and support both its halves using the same sample, time window, measure, and method.
We consider these results as a first step towards a fuller understanding of the determinants and effects of changes in employment protection legislation. The new evidence they offer is encouraging. They show that changes in labour market laws seem to be mainly driven by trade reforms and income levels and they also suggest that employment protection may decrease inequality without detrimental effects on economic growth. In our view, future research would hugely benefit from further measurement work. Further work is needed that differentiates between de jure and de facto liberalisation, and that dig deeper in the various facets of labor reform, within and beyond employment protection, including changes in unemployment benefits and active labor market policies.
- This blog post is based on the authors’ chapter “The Dynamics of the Regulation of Labour in Developing and Developed Countries since 1960,” Chapter 3 in N. Campos, P. De Grauwe and Y. Ji (eds.), The Political Economy of Structural Reforms in Europe, Oxford University Press, 2018, pp. 75-88.
- The post gives the views of its author(s), not the position of LSE Business Review or the London School of Economics.
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Nauro F. Campos is professor of economics at Brunel University London and research professor at ETH Zurich, research fellow of the Institute for the Study of Labour (IZA, Bonn) and a senior fellow of the ESRC Peer Review College.
Jeffrey B. Nugent is professor of economics at the University of Southern California (Los Angeles), research fellow of the Institute for the Study of Labour (IZA, Bonn) and senior research associate at the Economic Research Forum (Cairo).