Latin America: Tremendous social progress – World Bank

Latin America witnessed tremendous social progress during the last decade writes the World Bank in its report The Labor Market Story Behind Latin America’s Transformation (Adapted choosen excerpts by Job Market Monitor to follow).

Inequality of (labor and non-labor) income fell substantially, by 5 Gini points on average for 15 LAC countries, and the robust growth that the region experienced was remarkably pro-poor, with more than 70 million. Latin Americans lifted out of moderate poverty between 2003 and 2010. Latin America became also more globalized, strengthening trade links with China and the East Asian tigers, as well as more resilient, since the collapse of Lehmann Brothers and subsequent global crisis was felt in the region and left some scars, but the healing process was unprecedentedly fast. As expected, such new face of LAC was also felt in the main labor market aggregates. A few stylized facts that characterize the last 10 years of LAC economic history help illustrate this process:

• The unemployment rate declined in 3.5 percentage points, falling steadily in most countries for which we have comparable data;
• The set of skills brought by Latin American workers to the labor market improved rapidly. As the proportion of the employed labor force with primary education or less lost weight dramatically, by more than 10 percentage points, the share of workers with secondary education increased the most, by 7 percentage points;

Educational Attainment in LAC

• Inequality in labor earnings declined rapidly, by about 4 Gini points;

 Changes in the Monetary Labor Income Gini Coefficient

• The services sector continued to employ an increasing number of workers: its relative share in total employment increased by 2 percentage points;
• In spite of going through the worst international crisis since the Great Depression, real wages did not fall significantly during 2007-2009. From peak to trough, and driven by reductions in Colombia, Ecuador and Mexico, the real wage fell on average by less than 1percent, and it actually increased in Argentina, Brazil, Chile, Peru and Uruguay.

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Several conclusions emerge from the analysis:

• Changes in earnings inequality are the fundamental source of changes in the inequality of household income registered during the 2000s, suggesting that growth of output and employment played a greater role than social policy or, conversely, that social policy in LAC—while having had a major impact on poverty reduction—continues to be insufficiently redistributive. In most countries, the composition of labor force changed rapidly during the last two decades. The education levels of workers, in particular secondary attainment, increased steadily. Women kept up the rising trend in participation that started vigorously in the 1960s, albeit at a slower pace during the 2000s.
• These changes in the characteristics of the labor force, while impressive, do not appear to be a crucial factor in explaining the movements in labor income inequality. Instead, demand side forces appear to be playing a major role.
• The favorable terms of trade triggered by the commodity boom for the net commodity exporting countries in the region seem to have contributed to increase the relative demand for low-skilled workers, thereby playing a role in the decline in the returns to secondary and tertiary education.
• This decrease in returns to education, in turn, appears to have been an important driver behind the observed decline in labor income inequality, but not the only one, as returns to skills not directly measured through educational attainment fell as well.
• The secular reduction in inflation has introduced downward real rigidities in wages. However, the reduction in wage flexibility does not seem to have been accompanied by stronger fluctuations in unemployment or employment, in what appears to be a sign of increased efficiency in the labor market
• The decline in informal employment during the 2000s appears also to be related to the rapid expansion of large firms in the region, a sign of the importance of growth and productivity enhancement for the formalization of the economy.

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After a robust recovery following the global crisis, Latin American and the Caribbean (LAC) has entered into a phase of lower growth dynamics: economic activity in the region is expected to expand by about 3 percent in 2012, after having grown at 4 percent in 2011 and 6 percent in 2010. This deceleration is not specific to LAC but is part of a global slowdown. World growth is indeed declining sharply, from 4.5 percent in 2011 to about 2.3 percent in 2012.

Notably, the slowdown in middle-income regions has taken place in a highly synchronized manner: growth rates in LAC, Eastern Europe and South East Asia have fallen by a very similar magnitude (about 3 percentage points) between 2010 and 2012. While this synchronization reflects exogenous (global) forces—the spillover to emerging markets of weaker activity in the world’s growth poles, particularly Europe and China—it also reflects endogenous (internal) dynamics, particularly the fact that many Middle Income Countries (MIC) had already reached in 2010- 2011 the peak of their own business cycles.

This synchronicity notwithstanding, the 2012 growth forecasts for individual countries in LAC are significantly heterogeneous, reflecting complex interactions between external and country-specific factors. The sharpest growth deceleration is affecting Argentina, Brazil and Paraguay, whose economies are projected to expand well below the regional average of 3 percent. Of the countries projected to grow above the regional average, the ones that stand out are Mexico—where the post-global crisis recovery came with a lag but has gained momentum—as well as Bolivia, Colombia, Costa Rica, Ecuador, Chile, Dominican Republic, and Uruguay—whose growth rates, at around 4 percent, have surprised forecasters on the upside. Peru and Panama, for their part, continue to be the region’s top performers and are again expected to deliver Asia-like growth rates, of 6 and 8 percent, respectively.

For the near future, the main risks to LAC’s growth continue to come from the outside. But there has been a rebalancing of external risks in recent months in two main respects. First, the threat of an imminent is integration of the European Monetary Union has dimmed. Second, growth prospects for China have weakened and become more uncertain, with the debate intensifying on whether the current deceleration in China is purely cyclical—and could hence be soon cured by domestic stimulus policies—or more structural in nature—reflecting the beginning of a transition towards a more consumption-oriented growth model. Downside risks to LAC, and in particular to its commodity exporters, would be larger under the latter interpretation, especially if such a transition moves along a rocky path.

Even in the midst of this slowdown, labor markets in LAC have continued to perform remarkably well. The unemployment rate for the region as a whole closed at nearly 6.5 percent in 2011, the lowest since the peak of 11 percent in 2002-2003. This is not an isolated fact, it is rather a reflection of deep changes in Latin American labor markets that took place in the 2000s and which have, in turn, been part of a broader set of fundamental transformations (including the decline in household income inequality, the consolidation of sounder macro-financial frameworks and associated restoration of counter-cyclical policy capacity, the stunning reduction in poverty, the swelling of the middle classes, and the intensified connections to China) that jointly constitute what we have in the past labeled the “new face” of LAC. This report documents and discusses the labor market dimensions of this new economic face, dimensions that have hitherto been insufficiently studied. In doing so, it also complements the more global and general messages of the recently launched 2012 World Bank Development Report on Jobs.

Fueled by robust economic growth, employment in LAC during the 2000s expanded vibrantly compared to the sluggish 1990s. The expansion was sufficiently strong to absorb the continued incorporation of women into the labor force even as informality shrank, and the ranks of the unemployed steadily declined. Specifically, more than 35 million additional jobs were created while informality, one of the Latin American trademarks, fell in seven out of the nine countries where it can be measured consistently throughout the decade.

Strong employment creation during the 2000s was coupled with a sharp decline in the inequality of labor earnings, a second stylized fact that stands in sharp contrast with both international trends and the stagnation that characterized the region in the previous decade. For LAC as a whole, the Gini coefficient of labor income fell by four (4) points, a reduction of similar magnitude to the one registered by inequality in household income. This is not a coincidence, for the fundamental explanatory factor behind the decline in household income inequality was the reduction in wage inequality.

The important implication here is that growth of output and employment played a greater role than social policy in the decline of income inequality during the 2000s. Social policy did improve in the region over the decade (particularly through the introduction of well-targeted conditional cash transfer programs) and contributed significantly to poverty reduction, but it remained insufficiently redistributive, and even regressive, overall.

The decline in labor earnings inequality in the region may be due to changes in the composition of the labor force or changes in the remuneration of skills. Two salient compositional changes pertain to education and female labor force participation. On the one hand, the average years of schooling of the working class rose by about three additional years and, on the other hand, the entrance of women into the workforce continued during the 2000s, although at a slower pace than in the previous three decades. While both factors constitute fundamental transformations, they cannot explain the mentioned decline in wage inequality. In fact, female labor force participation and average years of schooling rose steadily in the 1990s and 2000s, whereas wage inequality increased over the 1990s (except in Brazil) but was on a
declining trend throughout in the 2000s.

The explanation of the fall in wage inequality, therefore, has to be found in the returns to skills. The fact that stands out in this regard is the decrease in the region’s education premium. In particular, the differential between the wages of workers with tertiary and secondary education, on the one hand, and those with primary education or less, on the other, entered a downward trend in the 2000s, after having been on the rise in the 1990s.

The relative importance of supply and demand factors behind this decline in the returns to education is difficult to ascertain. However, demand factors cannot be discarded, again considering that the supply of education increased throughout the 1990s and 2000s. A demand factor that is specific to the region and that appears to have played an important role is the commodity bonanza. It has promoted the expansion of the non-tradable sectors relative to (noncommodity) tradable ones in the commodity exporting LAC countries. And, at least in present-day LAC, the nontradable sectors (such as services and construction) tend to be on average less skill intensive that the (non-commodity) tradable ones (such as manufacturing). Hence, what appears as a fundamentally positive trend, the decline in household income and wage inequality, may hide a worrisome phenomenon, namely, the tendency in the region’s commodity exporting countries to specialize in sectors that are relatively less intensive in skills. This of course highlights the importance for reforms oriented at raising productivity in all sectors, including the non-tradable ones.

There is also some evidence pointing to a supply factor that may have also played a role in the fall in wage inequality in LAC. Specifically, the average quality of tertiary education may not have kept up with the rapid increase in its coverage. This hypothesis seems corroborated by an observed widening of wage inequality among workers with tertiary education during the last decade. This does not necessarily imply declining incentives to invest in tertiary education.

After all, and despite the mentioned equalizing trends, workers with tertiary education continue to earn substantially more that those with less education—even the bottom-paid college graduates earn much more than the average-paid workers with secondary education. The widening wage dispersion within university educated workers does point, however, to the need to put a policy premium on education quality.

Another set of momentous transformations in the labor field concern the changes in the patterns of cyclical labor market adjustments that occurred as LAC entered in the 2000s into an environment of low and stable inflation, finally breaking with its traditional history of home-grown macroeconomic instability. The dramatic decline of inflation in the region led to rising downward wage rigidities, which translated into lower fluctuations of earnings, especially during downturns. Perhaps more surprisingly, this declining variability in real wages was not matched by sharper swings in employment or unemployment, suggesting that LAC’s labor markets gained in efficiency and entered into a phase of less volatility during the 2000s. Certainly the largely favorable external environment that characterized the decade for LAC may have played a role in attenuating fluctuations. But better policies, such as a more credible conduct of monetary policy, appear to have helped as well in dampening fluctuations in the labor market. By succeeding in coordinating inflation expectations, the introduction of inflation targeting regimes seems to have shifted the focus of the wage setting process away from the nominal exchange rate and the minimum wage and, instead, towards the inflation target announced by the central bank.

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