Labor Market Institutions – High unemployment rates have weakened the prime facie case for deregulation and less intervention

Labor Market Institutions: A Review of the Literature by Gordon Betcherman on worldbank.org looks at the findings of over 150 studies on the impacts of four types of labor market institutions: minimum wages, employment protection regulation, unions and collective bargaining, and mandated benefits. The review places particular emphasis on  results from developing countries. Impacts studied are on living standards (employment and earnings effects), productivity, and social cohesion, to the extent that this has been analyzed.  Strong and opposing views are held on the costs and benefits of labor market institutions. On balance, the results of this review suggest that, in most cases, the impacts of these institutions are smaller than the heat of the debates would suggest.  Efficiency effects  of labor market regulations and collective bargaining  are sometimes found but not always, and the effects can be in either direction and are usually modest. Distributional impacts are clearer, with  two effects predominating: an equalizing effect among covered workers but groups such as youth, women, and the less skilled disproportionately outside the coverage and its benefits.  While the overall conclusion is one of modest effects in most cases, this does not mean that impacts  cannot be more dramatic where regulations are set or institutions operate in ways that exacerbate the labor market imperfections that they were designed to address.

Controversies over the role and impacts of labor market institutions have continued over the past two decades. In fact, this debate has intensified as globalization and technological change have exposed developed and developing countries to greater competition and raised the stakes for finding the optimal institutional framework. Through this period, the  body of empirical evidence on the impacts of labor market institutions has continued to grow.  Research in the 1990s, largely based on cross-country regressions, typically found that strong protective legislation and generous unemployment insurance did slow job growth and increase unemployment. These conclusions motivated the influential OECD (1994) Jobs Study  which took a largely deregulation stance, recommending flexible rules for protecting employment and setting wages and hours, and unemployment and  welfare systems that  minimized work disincentives.  A parallel body of evidence did not yet  exist for developing countries but  the dominant policy message was similar: while institutions were introduced with good intentions and had a role in addressing market failures, they often had unintended negative consequences in terms of both efficiency and equity.

This is not the end of the story, however. As methods have improved and as better data have become available since the mid-1990s, the real impacts of most labor market institutions have become less—not more—clear. Indeed, in its assessment of labor market developments since The Job Strategy, the OECD (2006) was more equivocal about almost all of its recommendations than it had been 12 years earlier. Moreover, in the wake of the global recession, the stubbornly high unemployment rates in the U.S. and some other less regulated (largely Anglo-Saxon) countries have weakened the prime facie case for deregulation and less intervention in the labor market. The case for a ‘single peak’ of superior labor market performance (e.g., deregulation, ―light‖ institutions) has been supplanted by arguments for ‘dual or even ―multiple’ peaks where comparable levels of performance can be reached using various regulatory and institutional combinations.