Abstract
This paper constructs a theoretical model to study labor market regulations in developing countries within the context of structural transformation. When workers are risk averse and the market for insurance against labor income risk is missing, regulations that provide insurance to workers (such as severance payments) are efficiency enhancing and promote structural transformation. However, regulations that simply create barriers to the dismissal of workers not only impede structural transformation, they also end up reducing the welfare of workers. The implications of some other issues like general regulatory burden, weak state capacity, and minimum wage regulations are analyzed as well. The paper provides some empirical evidence broadly consistent with the theoretical results using cross-country data. While dismissal regulations increase the share of informal employment, severance payments to workers do not.
Highlights
Structural transformation is an integral process of economic development whereby resources move from less productive activities to more productive activities
Aside from gross domestic product (GDP) per capita and the share of agriculture in total employment (Agrishare), both of which are from the World Development Indicators database, respectively, we include as controls measures of the ease of paying taxes and access to credit provided in the World Bank's Doing Business (DB) database
Our results suggest that getting rid of regulations that protect jobs and not workers is a good idea
Summary
Structural transformation is an integral process of economic development whereby resources move from less productive activities to more productive activities. The aim of this paper is to provide an analytical framework to analyze labor market regulations in developing countries and study how they affect the intrasectoral allocation of resources between informal and formal firms. It provides some suggestive empirical evidence broadly consistent with the theoretical results. We construct a theoretical framework with two key features: risk-averse workers and the existence of an informal/unorganized sector These two features allow us to study labor market regulations in a developing country context.
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