Regulating labour market

Intervening by government in labour market
Labour and capital are joint factors in the transformation of raw materials into final products. One of the aims of economic policy is to ensure that these two factors are combined efficiently. But in addition to this, governments in developing countries are also anxious to expand employment opportunities for those entering the labour force in ever increasing numbers. In the next few decades, industrial employment will be a key element in creating jobs, reducing poverty and raising standards of living.

Urban labour markets in developing countries often have a formal sector, usually comprising the government itself and the modern manufacturing sector, and an informal sector comprising small family-owned enterprises that usually lie outside the purview of government labour regulations. In some countries, labour markets are reasonably efficient and wage differentials are determined largely by differences in education and experience. But in others there are large wage differentials for unskilled labour between the formal and informal sectors; and high rates of urban unemployment, especially for educated labour, are common. Some wage differentials can arise as a result of sex, ethnic or race discrimination and can be corrected only through education and social and cultural change. Other differentials may be due to minimum wage laws, payroll taxes and the hiring practices of the public sector.

To achieve greater equity and promote social justice, governments in many developing countries intervene in labour markets to protect the real wages of particular groups of workers. Methods include:< 1. Minimum wage legislation, which has been an important influence on real wages in manufacturing, although its significance has declined since the early 1980s and real wages have declined substantially as a result. However, in Africa and parts of Asia, governments will come under increasing pressure to reactivate such legislation once their economies adjust and expansion resumes. This may have the result of reducing employment in the formal sector. Research shows that on average a 1% increase in the real wage tends to reduce employment by about 0.03 to 0.04%.

2. Payroll taxes, by means of which many governments, especially in Latin America, tax employers on the number of their employees. Industries with relatively high payroll taxes tend to pay lower wages, which passes nearly all the tax onto the workers. But when a binding minimum wage law or strong workers' union prevents wages from falling, the effect of a payroll tax on employment is identical to an increase in the legal minimum wage.

3. Public sector wage policy as an important force in the determination of wages. Pay scales for unskilled workers in the public sector are generally higher than in the private sector and are usually unresponsive to labour market conditions. These pay scales often extend to public industrial enterprises, where managers usually do not have the same discretion as their private sector counterparts in dealing with their staff. The consequent loss in competitiveness can be transmitted to the rest of the industrial sector, particularly if the output of public industrial enterprises is used as input by the rest of the industrial sector.

4. Limiting the freedom of employers to lay off workers. Even where reductions in the work force are allowed, employers are sometimes required by law to provide severance payments based on wage and length of service. These legal provisions can make it difficult to respond to changes in demand and production requirements. They raise the effective cost of labour and lead managers to substitute capital for labour. And legally guaranteed job security reduces the incentives of workers and managers to increase their productivity. Panama introduced a labour code in 1972 that restricted layoffs of workers with more than two years of employment. A decline in private sector investment followed, and over the next few years employment fell much faster than output. Eventually, firms began to discharge workers before they had two years of seniority.

Counter Claim:
If governments reduced their labour market interventions, their economies would grow faster. Repealing minimum wage laws would not condemn the urban labour force to stagnant incomes. Average wages should rise as workers shift from low-wage, low-productivity jobs to higher paying jobs in high-productivity industries. In the Republic of Korea, for example, five to seven years after the shift from an import substitution strategy to an export oriented one in the early 1960s, wages rose rapidly despite the absence of government intervention. Policies on finance, labour and taxes tend to raise wages relative to the cost of capital and therefore depress employment. A study based on a 70 country sample showed that if the level of wages increased by, say, 10% relative to the rental rate of capital, the proportion of labour employed would fall on average by 10% relative to the amount of capital.
Type Classification:
D: Detailed strategies
Related UN Sustainable Development Goals:
GOAL 8: Decent Work and Economic GrowthGOAL 16: Peace and Justice Strong Institutions