Labor Market Regulations in the Context of Structural Transformation | Asian Development Bank

Labor Market Regulations in the Context of Structural Transformation

Publication | April 2018
Labor Market Regulations in the Context of Structural Transformation

Labor market regulations that provide insurance to workers are efficiency enhancing and raise the fraction of workers employed in the more productive formal sector.

Determining what types of labor market regulations are optimal is challenging. Governments in developing countries attempt to regulate labor markets through wages, hours of work, hiring and firing restrictions, and work conditions. This paper constructs a theoretical model to study labor market regulations 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 are enhancing and raise the fraction of workers employed in the more productive formal sector. However, regulations that create barriers to the dismissal of workers may impede the transition to formal sector employment and reduce workers‘ welfare. Empirically, the paper finds that dismissal regulations increase the share of informal employment; however, severance payments to workers do not.

Contents 

  • Introduction
  • Related Literature
  • The Model
  • Planner's Problem
  • Labor Market Regulations
  • Empirical Exercise
  • Concluding Remarks
  • Appendix