1 chapter 14 structural adjustment: agriculture, trade, and the labor market © pierre-richard...

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Chapter 14 Structural Adjustment:

Agriculture, Trade, and the Labor Market

© Pierre-Richard Agénor

The World Bank

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Price Reform in Agriculture Trade Liberalization Trade and Regional Economic Integration Reforming Labor Markets

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Structural Adjustment Structural reforms: policy measures that increase

productive capacity or degree of flexibility of the economy.

Structural policies have implications on both micro and macro dynamics: micro: ultimate objective is to improve efficiency in

resource allocation by reducing various distortions;

macro: make markets more flexible and enhance the economy’s ability to absorb domestic and external shocks.

4

Price Reform in Agriculture

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A common argument: agricultural policy has a high implicit tax burden.

Subsides: government marketing boards pay domestic producers less than world market prices for output.

Logic: alter the distribution of income in the economy.

Two problems with food subsidies: Inefficient means of redistributing income relative

to direct and well-targeted transfers. Lower food prices artificially reduce domestic

production, increase migration to urban areas urban unemployment.

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Result: policy not only may impose a direct drain on the budget buy also exacerbate balance of payment and unemployment difficulties.

Taxation leads to similar effects: Export tax: for a long time the principle mechanism

through which agriculture was taxed. Price ceiling: effective tax on output and subsidy on

consumption. Deaton and Benjamin (1993): Coffee and cocoa

pricing policies raised almost 40% of government revenues in Cote d’Ivoire in early 1980s.

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Agricultural tax burden: Schiff and Valdes (1992): urban bias; marketing

boardsdisincentive for agro-production; add over-valued exchange rate distributional shift against the rural sector.

Reforms Elimination of export duties, reduction in world and

domestic price gaps. Sub-Saharan Africa: deregulation of agricultural

prices and the dismantling of agricultural boards.

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Effectiveness World Bank (1994, see Tables A9 and A18): average

domestic terms of trade for export crops improved in only 10 of 27 sub-Saharan African countries between 1981-81 and 1989-91.

World Bank User:

Yo Richard, this all seems pretty cirular in terms

of the agricultural tax business. Why don’t we just come out and

say that the goal is to 1. Achieve a better ditribution of income and 2.

Growth.

So in the end, the issue of

income redistribution

becomes a question of finding an

efficient means of pulling it off. E.g. not defacto

agricultural taxation which

creates the distortions in

rural-urban and terms of trade weakening, but instead through

effective land reform,

infrastructure, (rural credit

markets, why?) and

encouragement of small-scale

production methods...

World Bank User:




Growth.










markets, why?) and



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World Bank (1993): urban-rural income gap relatively small in high performing Asian countries.

Lower gap: reduces incentives to migrate out of agricultural

employment; reduces urban unemployment; reduces government revenues.

First best methods of promoting greater income distribution:

Reform of agricultural taxation coupled with land reform, increased provision of infrastructure, development of rural credit markets, and encouragement of small-scale production methods.

World Bank User:




Growth.










markets, why?) and



World Bank User:




Growth.










markets, why?) and



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Trade Liberalization

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Recognition of the severe allocative distortions of import substitution strategies has led to more liberal external trade regimes among developing countries.

Why? Reduction in trade barriers (tariffs, import quotas)

fosters relative price adjustments, leads to a reallocation of resources toward exportable sector.

Leads to an expansion of output of exportables vis-à-vis import-competing industries.

Static output gain and dynamic gains from free trade. Removal of barriers to trade may lead to permanent increase in economy’s growth rate as a result of technological spillovers.

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The Gains from Trade Understanding gains from trade requires

understanding the efficiency loss associated with the imposition of a tariff in the first place.

Hekscher-Ohlin-Samuelson model:

Model assumptions: perfectly competitive and efficient markets; incomplete specialization with relative factor

endowments; international immobility of factors; exogenous terms of trade in the domestic

economy.

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See Figure 14.1: Case of small open economy producing one importable good partial equilibrium setting.

Imposition of a tariff: Deadweight loss associated with the loss of

consumers’ surplus far outweighs increase in the producers’ surplus and the increase in government revenue.

Welfare loss due to the tariff:

W J/2

J: change in imports;

: tariff rate.

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Figure 14.1a Effects of a Tariff in a Small Open Economy

J

a b c d

D

P J

P*J

P =(1+ )P*JJ

S

S*

B0 D C A

S

D

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Figure 14.1b Effects of a Tariff in a Small Open Economy

C

C'

A'

A

I0

I1

*

P

X

P J

H

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If free trade price, P*J, equals unity, then J equals

JJ with J: price elasticity import demand, Meade formula,

W 2 JJ /2.

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General Equilibrium setting

Figure 14.1 (bottom): PP: production possibility frontier; maximum physical

production of X and J producible given economy’s productive capacity and state of technology.

Marginal Rate of Transformation: slope of PP. I0 and I1: social indifference curves; combination

baskets of X and J among which society obtains equivalent utility.

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Marginal Rate of Substitutions: slope of society indifference curves.

: For X (exports) and J (imports) measures relative price of importables/exportables, MRS, taken as exogenous.

Tariff, on J distorts domestic relative price ratio from * to,

= (1 + )PJ /PX

Exportable (importable) sector contracts (expands). Tariff is sub-optimal.

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Can an import tariff be optimal?

Aizenman (1987): In the absence of collection costs for tariffs and an

inelastic labor supply, optimal tariff is,

= /( - )

: cost of collecting alternative taxes (in percent);

: price elasticity of import demand.

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Dixit (1985): criticized above argument; possible to generate same revenues as tariff w/

neutrally levied tax on both domestic and foreign goods;

collection costs may be low but enforcement costs could still be quite high.

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Dynamic gains from trade

Romer and Rivera-Batiz (1991): Lowering barriers to trade can affect growth through

at least 3 mechanism: Transmission of technology: accumulation of

knowledge, as a public good, increases rate of technical progress.

International integration of sectors characterized by increasing returns to scale raises output without requiring more inputs.

Trade liberalization reduces price distortions, reallocating resources across sectors and increasing economic efficiency.

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Strategic Trade Theory

Helpman and Krugman (1985): Scale economies and externalities: larger

producers have advantage, e.g. larger market sizes ceteris paribus optimal.

Rodrik (1988): Considered a country with high tariffs and imperfect

competition. Net effect of tariff reduction was a priori

ambiguous. Trade reform affects welfare through traditional (e.g.

volume of trade effect) channels and also assumptions about market structure.

World Bank User:

Yo, so what is it about Rodrik’s

study that implicates tariff reductions on the downside.

Not explained in the text, i don’t

think.

World Bank User:




think.

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Baldwin (1992): Strategic trade theory not easily generalizable. Contingent on assumptions about market structure,

entry and exit restrictions, and intersectoral linkages.

Information that is in practice very difficult to obtain.

World Bank User:




think.

World Bank User:




think.

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Recent Evidence on Trade ReformsFour reasons to be careful about using nominal

tariffs as a proxy for openness; Instrument substitution: nominal tariffs may be

lowered, but other restrictions--such as anti-dumping measures--may take its place.

Nominal tariffs and effective tariffs may differ due to certain exemptions.

Tariff redundancy: after reform, overall structure may become more protective.

Other anti-export biased policies, e.g. overvalued exchange rate etc., ultimately help account for degree of trade liberalization.

World Bank User:

Yo, what the &^%^ are you

talking about here…

World Bank User:

Yo, what the &^%^ are you

talking about here…

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better way of looking at bias of trade regime; dependent on input coefficients and tariffs on

inputs;

detailed input-output tables necessary; thus, nominal tariffs, despite their limitations, are

frequently used as indicators of changes in the trade regime.

value added in international prices

Effective Protection Rates:

(value added at domestic prices - value added in int’l prices)

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Figure 14.2: nominal tariffs, developing countries, 1980-95:

Average tariff rates fell substantially in several developing countries.

India: maximum tariff on imports; 400% in 1990 50% in 1995, average tariff rates; over 80% to under 30% over the same period.

Latin America: tariffs lowered from 41.6% in 1985 to 13.7% in 1995 (Lora and Olivera, 1998, p. 13).

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Figure 14.2Import Duties

(In percent of merchandise imports)

Source: World Bank.

1980 1995

Colombia

Costa Rica

Ecuador

Egypt

Ethiopia

Ghana

Indonesia

Jordan

Kenya

Korea

0 5 10 15 20 25 30

Kuwait

Malaysia

Mexico

Pakistan

Philippines

Sri Lanka

Syria

Thailand

Turkey

Venezuela

0 5 10 15 20 25

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South Asia: unweighted tariff averages on manufactured goods fell in the early 1990s to 11% in Korea, 15% in Malaysia, and 11% in Taiwan; remained at 42% in Thailand, 56% in India, 64% in Pakistan, and 85% in Bangladesh (Bandara and McGillivray, 1998).

Figure 14.3: reduction in mean tariffs associated with a reduction in dispersion of tariff rates.

Sub-Saharan Africa: region with least progress in trade liberalization: sub-Saharan Africa’s exports: 3% of world

exports in 1955; by 1990, barely above 1%;

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Figure 14.3Mean Tariffs and Tariff Dispersion

(Averages over 1990-93)

Source: World Bank.

Sta

ndar

d de

viat

ion

of ta

riff r

ates

Mean tariff on imports (in percent)

0 5 10 15 20 25 30 35 40 45 50 55 60

0

5

10

15

20

25

30

Colombia

SingaporeCôte d'Ivoire

Nepal

Ghana

Korea

Tanzania

Chile

Malaysia

Indonesia

Brazil

Bolivia

Philippines

Honduras

Peru

Thailand

Morocco

Algeria

Tunisia

Nigeria

Pakistan

Zambia

Kenya

India

Venezuela

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decline in global demand for sub-Saharan products and a substantial erosion of its market shares;

World Bank: if sub-Saharan Africa had maintained its 1962-64 export shares, region's exports would now be more than double their current value;

antiexport bias still characterizes many trade regimes in region (Ng and Yeats, 1997).

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Trade Reform, Employment, and Wage Inequality Short- and intermediate-run impact of trade reform

on wages and employment remains imperfectly understood.

Evidence: World Bank study in early 1980’s, inconclusive:

manufacturing sector employment either fell or remained stable after liberalization program;

however, study did not distinguish between traded and nontraded manufacturing goods and didn’t look at aggregate unemployment rate.

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More recent studies Rama (1994): Lower tariffs in manufacturing sector

in Uruguay had no impact on wages, negative effect on employment. Reducing tariff inclusive import prices by 1%, decline in employment by .4-.5%.

Revenga (1997): Reducing tariffs by about 10% in Mexico led to a 2-3% decline in manufacturing sector employment and an increase in average wages.

Currie and Harrison (1997): Morocco, 1984-1990 coverage of import licenses reduced from 41% of imports in 1984 to 11% 1990, reduction in the maximum tariff rate from 165% to 45%---formal manufacturing sector, small, significant impact, also pronounced sectoral shifts in employment.

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Márquez and Carmen Pagés-Serra (1998): effect of trade openness and real exchange rates on demand for labor in manufacturing sector in 18 countries in Latin America and the Caribbean. Found that trade reform has a negative but small effect on employment, reinforced by real exchange rate appreciation.

Income distribution: openness, since 1980s, has coincided with an increase in the relative wages of skilled versus unskilled labor.

Revenga (1997): for Mexico, rise in average manufacturing wages caused by change in labor composition, e.g. shift towards high-skill, high-wage workers.

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Currie and Harrison (1997): for Morocco, found similar divergence in relative wages and demand for labor.

Chile: wages of university graduates rose by 56% relative to those of high-school graduates between 1980 and 1990. 1990s suggest that wage differentials may have remained largely unchanged in Argentina, Chile and Costa Rica (Lora and Olivera, 1998).

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Hecksher-Ohlin-Samuelson (HOS) Model Principle of comparative advantage: pattern of

trade across countries based on relative factor abundance.

Two theorems derived from HOS Model: Factor price equalization theorem (FPE): Under

HOS assumptions, prices of production factors will equalize across trading partners.

Stolper-Samuelson (S-S) theorem: A(n) decrease (increase) in the tariff on a good will decrease (raise) the real price of the factor of production that is used relatively intensively in producing that good.

See Figure 14.4 for graphical illustration.

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Figure 14.4 The Stolper-Samuelson Theorem

Source: Adapted from Mikic (1998, p. 91).

0 w

r

P X

E

E'

BE''

P X

P J

P J

rE''

rE

wE''

wE

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Explanations for the fall in unskilled wages:

S-S Theorem Reduction in the relative price of unskilled labor-

intensive goods brought about by a tariff reduction will unambiguously reduce unskilled labor wages.

Capital goods, skill-intensive goods spiral: an alternative explanation.

Trade liberalization is associated with the introduction of higher-level technology.

Assumption that the cost of capital falls alongside trade liberalization, leading to increased imports of capital goods, and expansion of exports of skill-intensive goods. in turn, the wage gap between skilled and unskilled labor widens.

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Obstacles to Trade Reform Progress has remained slow in some countries,

particularly in sub-Saharan Africa.

Matusz and Tarr (1999) Adjustment costs associated with trade liberalization

typically very small compared with benefits.

Then why is trade reform unpopular? Influence of powerful groups. Political considerations instead of cost/benefit

analysis. Rent-seeking activities.

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Rodrik (1995c): Two obstacles to trade reform:

status quo bias, associated with individual uncertainty;

high political costs compared with efficiency gains.

Fernández and Rodrik (1991): Idiosyncratic uncertainty: since individual winners

and losers can’t be identified before implementation; ex ante individuals may oppose reforms; even if ex post everyone should support them.

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Example:

Idiosyncratic uncertainty in action: economy with 100 workers; employed in two sectors, W and L; 40 in W, 60 in L.

Faced with a reform in which: each worker in W gains 0.2; each worker in L loses 0.2; 20 workers will move from L to W.

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Full information Ex post: a majority will approve, 60 (in W) vs. 40 (in L).

Individual uncertainty

Ex ante results change by the following logic: Suppose each person in L faces identical odds of

staying (40/60) in L and walking to W (20/60): expected gain from reform;

0.2 (1/3) - 0.2(2/3) < 0, majority in L will rationally vote against reform; paradox: a benevolent dictator could produce the

optimal ex post outcome.

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Overcoming status quo bias: can try to design more appropriate transfer

schemes; can try to create an insurance market to allow

individuals to protect against uncertain outcome.

High Political Costs: Welfare costs of trade distortions, measured by

Harberger triangle, are relatively small, (2% or less of GDP).

Simultaneously, trade liberalizations typically involve large reallocations of income, with high political costs that may generate resistance to reform (Rodrik, 1992).

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Rodrik’s political resistance to reform ratio: Rodrik considered a small open economy with:

price of importables/exportables, p*; initial tariffs, pd > p*;

then a convergence of pd p* implying a loss of government revenues, a gain in consumer surplus and a loss of producer’s surplus (see Figure 14.1).

Political resistance to reform ratio: total income lost

both by the government (foregone tariff revenue)

and producers divided by the total efficiency gain.

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Rodrik (1998): Large distributional effects of trade reform explain

low credibility in sub-Saharan African countries. Opposition to trade reform often more localized and

organized than political opposition to macroeconomic stabilization (Tommasi and Velasco, 1996).

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Situation where authorities announce permanent tariff abolition but private sector discounts a policy reversal.

Low credibility of the tariff reform can trigger speculative accumulations of inventories.

While profitable to private sector, not pareto optimal for the society as inventory accumulations may crowd out alternative acquisitions with higher social returns.

Calvo (1989)

Lack of credibility as a distrotion or a production tax that limits beneficial effects of trade reform.

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perfect capital mobility facilitates unlimited foreign capital for inventory speculation;

capital controls can limit speculative process.

Social cost of policy uncertainty: function of capital markets structure;

Adverse revenue effects: a further explanation of trade liberalization procrastination; countries reliant on trade taxes display slower trade

reform; trade liberalization may lower revenue in short term; however, some liberalization measures (e.g. tariff

instead of quota) possible w/out meaningful declines in revenues.

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Increase in revenue possible: if lower tariffs are accompanied by volume

increases (import elasticity vital); trade liberalization concomitant with exchange rate

liberalization, fall in exchange rate leads to increase in

domestic-currency price of imports to offset loss of percentage tariff revenue in local currency terms.

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Trade and Regional Economic Integration

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Composition of exports Manufacturing goods share of total exports

Asia: from 42% of total exports in 1970 to 48% in 1980 to 74% in 1990.

Latin America: from 12% in 1970 to 18% in 1980 to 34% in 1990.

Africa: from 15% in 1970 to 27% in 1980 and fell to 22% in 1990.

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shift in comparative advantage; lower relative wages and greater investment leading to increased competitiveness in manufactured goods;

in Asian countries: high domestic saving and investment rates leading to increases in the stock of capital.

Export composition changes resulting from removal of domestic market distortions lower trade barriers and most significantly,

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Export diversification and intraregional trade:

Figure 14.5: displays export diversification between 1984 and 1994.

Asia: nearly 40% of the region's exports now going to other Asian countries.

Latin America: export diversification more limited, almost 50% of region's exports shipped to North America.

African countries: relatively undiversified, almost 50% of the region's exports going to Europe, and level of intraregional trade remains modest.

Middle East and Europe: diversification relatively small; importance of intraregional trade actually diminished between 1984 and 1994.

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Figure 14.5aDeveloping Countries: Diversification of Export Markets 1/

(In percent of total exports)

Source: International Monetary Fund.

1/ Export shares of each region to all developing and industrial countries do not add to 100 percent because trade with the countries in transition is excluded and because of some underreporting of trade.

1984 1994

to Africa

to Asia

to Middle East

0 10 20 30 40 50 60 70

Exports from Asia

to Africa

to Asia

to Middle East

0 20 40 60 80

Exports from Africa

to all Developing Countries

to all Industrial Countries

to Western Hemisphere




53

Figure 14.5bDeveloping Countries: Diversification of Export Markets 1/



1/ Export shares of each region to all developing and industrial countries do not add to 100 percent because trade with the countries in transition is excluded and because of some underreporting of trade.

1984 1994

to Africa

to Asia

to Middle East

0 20 40 60 80

Exports from Western Hemisphere

to Africa

to Asia

to Middle East

0 20 40 60

Exports from Middle East







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Figure 14.5cDeveloping Countries: Diversification of Export Markets 1/



1/ Export shares of each region to all developing and industrial countries do not add to 100 percent because trade with the countries in transition is excluded and because of some underreporting of trade.2/ North America, Australia, Japan, and New Zealand. "All industrial countries" includes, in addition, Europe.

1984 1994

to Africa

to Asia

to Middle East

0 25 50 75 100 125

Exports from Other Industrial Countries 2/

to Africa

to Asia

to Middle East

0 20 40 60 80

Exports from Europe







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Preferential trade agreements:

Mercosur agreement: Brazil, Argentina, Paraguay, and Uruguay. Commenced January 1, 1995. Common external tariff (CET) structure

0 to 20% on about 85% of all traded goods; can only be modified with consent of all four

partners; 15% of goods outside the CET structure, divided

into three categories subject to adjustment schedule to converge with CET rates within next 5-6 years.

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Three categories of goods currently outside CET: National exceptions: Each country can identify up

to 300 items for temporary exemption from the CET. Tariffs on these goods must converge with the CET by the year 2001.

Capital goods: exempted from the CET structure for all countries but convergence timetable varies. 2001: Argentina and Brazil; 2006: Paraguay and Uruguay.

Computer goods: convergence to the CET set to occur by 2006. Average tariff rate in Brazil, 30%, scheduled to fall to 15% by 2006.

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No tariffs on intraregional trade with exception of, Adjustment Regime: allowed each country to

maintain tariffs for items on a preapproved list until January 1, 1997, for Argentina and Brazil, and January 1, 2000 for Paraguay and Uruguay.

Benefits of regional trade: allow firms to spread R&D costs over a larger market,

reducing unit costs and encouraging innovation; positive spillovers: as successful innovations are

applied more broadly; integration can boost productivity growth, allowing

increased specialization; efficiency gains from increased competition,

reinforced by foreign direct investment.

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Policy issues raised by preferential trade agreements .

Bhagwati and Panagariya (1996): Preferential trade agreements may conflict with

multilateral agreements (e.g. WTO). Preferential trade arrangements not only can lead

to trade creation, but also trade diversion; imports switching from more efficient nonmember suppliers to less efficient member suppliers.

Higher trade volumes between member countries may lead to greater losses to an individual member Z that joins from a set of high initial tariffs levels.

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Trade creation vs. diversion: partial equilibrium setting

Viner (1950): Given, two countries, A and B, producing the same

good and considering forming a preferential trade arrangement with a customs union.

A and B both face constant world price, P*. Suppose A is an importer of the good from B and the

rest of the world. B is a net exporter. Before custom union, A imposes nondiscriminatory

tariff rate, , on all imports.

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B initially has no tariff. Before union B exports only to A. With union, two countries are self-sufficient at price PU

> P* < (1 + )P*. See Figure 14.6. Three types of effects on A:

trade creation effect; trade diversion effect; consumption effect.

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Figure 14.6Customs Union: Trade Diversion and Trade Creation

e

P

P

QE

A

Q A

P* PU (1+ P*

D A

S A

QCA

QE'A

QC'

A

d

c

b

f

g

D B

SB

QE'B

Q B

QC

B

QE

B

QC'

B

m

n

k

j

P* PU

Total imports, J AQJ

A

Initialimports from B

Initialexports to A Post-union exports to A

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Customs unions and welfare, the analytical evidence: More competitive and complementary union partner

production structures increase likelihood that customs union increases welfare.

Reason: more scope for trade creation among countries

whose production structures are similar, because less efficient domestic production tends to be replaced by imports from partner countries.

Larger cost differentials increase scope for gains from trade creation effects.

Higher initial tariffs between union partners, increase scope for trade creation and welfare gains.

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Lower tariffs imposed on non-members decrease trade diversion.

The smaller the share of goods imported from nonmember countries in total consumption prior to the union, the greater the higher the benefits for members.

Assessing net welfare effects of these arrangements requires examining dynamic effects associated with greater scope for economies of scale, increased competition, and larger investment and technology flows across member countries (see Baldwin and Venables, 1995).

64

Reforming Labor Markets

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Labor market flexibility and economic growth: Observers have argued that key feature of the East

Asian growth miracle (mirage) was the limited impact of trade unions and other distortions on the labor market (Fields and Wan, 1989).

Asia was also able to sustain high levels of employment growth without wage pressures.

Viewed as a result of effective investments in primary and secondary education, which have ensured an ample supply of skilled workers and helped to prevent large changes in relative incomes (Fields, 1994).

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circumventing the scope of hiring and firing regulations;

reducing nonwage labor costs; eliminating (or restricting the scope of) minimum

wage laws; limiting unemployment benefits; curtailing the role of trade unions in the wage

bargaining process.

Labor market reform advocates support the following as having positive effects on growth:

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We take a more balanced approach: review some known facts about labor markets in

developing countries; consider various types of labor market reforms

aimed at increasing economic flexibility; conclude by examining the link between labor

market regulations and growth.

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Labor Markets in Developing CountriesTypically consists of three sectors: Rural sector: particularly large in sub-Saharan

Africa. Informal urban sector:

mostly self-employment and limited hired labor; characterized by high wage flexibility and low

employment security. Formal urban sector:

explicit contracts; high compliance with labor market regulation;

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wage determination departs from market clearing mechanisms due to legal restrictions, labor unions, and considerations internal to firms.

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Employment Distribution and Unemployment

Proportion of wage earners; high in Asia/Latin America, very low in sub-Saharan Africa (about 10%).

Public sector absorbs a large share of formal wage employment in some countries.

Share of informal sector employment in total urban employment is sizable, exceeding 60% in India and Kenya.

In many countries in Latin America, the informal sector grew in importance during the 1980s and early 1990s, accounting for more than 50% of total employment in 1992 (see Agénor, 1996).

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Unemployment insurance, not well developed, desirability questionable:

Negative: disincentive to search for (or to accept) employment, incentive to enter the labor force in order to collect unemployment benefits.

Positive: encourages labor force participation and regular over marginal, employment (Atkinson and Micklewright, 1991).

Disguised unemployment Underemployed workers in the informal and rural sectors Published unemployment only captures the formal sector. 25-60% of labor force in some countries.

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Empirical evidence difficult to capture: elasticity of unemployment with respect to

replacement rates (benefits before taxes as a percentage of previous earnings) may be relatively low;

but whether high unemployment benefits tend to increase unemployment remains an open issue.

73

Wage Formation and Labor Market Segmentation Labor market segmentation: situation where

observationally identical workers receive different wages depending on their sector of employment.

Induced by various factors: government intervention in the form of minimum

wages; trade unions imposing wage premium for members; efficiency wages: resulting from nutritional factors

(Bliss and Stern, 1978), turnover costs (Stiglitz, 1974) or productivity considerations (Stiglitz, 1982).

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Efficiency wages: Firm set wages to minimize labor costs per

efficiency unit rather than per worker costs: level of effort may be positively related to the pay; firms wage-setting decision may be a markup of

the formal sector over the informal sector; as the efficiency wage may exceed the market-

clearing wage, such models also help to explain the existence of involuntary unemployment;

See Annex A for a model of the urban labor market in developing countries.

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Minimum Wages

Arguments in support of a minimum wage: has positive nutritional effects; is an instrument of income redistribution and social

justice; can raise productivity.

76

Arguments against minimum wage: prevents downward adjustment in wages, leads to

an excess supply of labor, imposes an implicit tax on employers in the formal economy;

creates unemployment, induces labor market segmentation, and lowers wages in informal urban sector;

increases the cost of employing unskilled workers relative to capital, accelerates substitution of capital for unskilled labor;

over time a high minimum wages restrains the aggregate expansion of the labor market.

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Empirical evidence Mixed and inconclusive.

Difficulties: Lack of legal compliance renders studies based on

the formal sector highly imprecise. Large share of workers in one formal-sector industry

may be paid below minimum wages whereas the other share may earn wages in excess of the minimum wage.

Controlling for differences problematic, not a function of worker or firm characteristics.

78

Nevertheless, some recent studies have suggested that the employment effects of changes in minimum wages are either limited or even positive.

Bell (1997): Although changes in the minimum wage seemed to

affect the distribution of wages in Colombia and Mexico, they appeared to have a limited impact on employment.

Rama (1995): Minimum wages did not significantly effect economic

growth. Higher minimum wages appeared positively

correlated with employment growth.

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But changes in the minimum wage are likely to have important distributional effects among workers, for instance, between those employed in the formal sector and those in the informal sector.

Trade Unions and the Bargaining Process Trade union in developing countries typically are not

very centralized. Collective labor action is difficult to organize.

However, the degree of unionization is a highly imperfect measure of trade union influence.

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Strategic sectors or industries may exert considerable influence on wage formation and working conditions at the national level, even if overall union membership is low in proportion to the work force.

Calmfors (1993): Relationship between the degree of centralization in

wage bargaining (the extent to which unions and employers cooperate in wage negotiations) and wage pressures is an inverted U-shape.

Wage push is limited when bargaining is highly centralized and when highly decentralized.

81

Highest influence on wage formation tends occur when centralization is in the intermediate range, that is, at the industry level.

Explaining inverted U-shape (see Calmfors, 1993): High degree of centralization implies a high level of

cooperation between unions and employers that leads to an internalizing of wage increases, lowering the marginal benefit of an increase in wages.

Competitive forces lead decentralized bargaining systems to produce real wage moderation.

82

Under intermediate centralization, neither internalization effects nor competitive forces are sufficiently strong to restrain unions' incentives to demand higher wages.

Recent research disagrees.

Cukierman and Lippi (1998): Higher centralization has two opposite effects on

real wages: less effective competition among unions; this

competition effect tends to raise real wages; strengthens the moderating influence of

inflationary fears on the real-wage demands of each union; this strategic effect tends to lower wages.

83

Direct impact of unionization on wages: Nelson (1994) argued that in Latin America, unions

lead wages to rise above the opportunity cost of labor through a combination of union pressure, minimum wage legislation, and wage policies in the public sector.

In Taiwan and Korea, unions have limited power in bargaining over wages (Fields, 1994).

Park (1991): blue-collar workers in the unionized manufacturing sector in Korea are paid on average only 4 percent more than their counterparts in the nonunionized sector.

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Panagides and Patrinos (1994): union-nonunion wage differential in Mexico was about 10 percent in the late 1980s.

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Labor Market Reforms and FlexibilityAdverse consequences of job security provisions: General loss of profitability, reduced flexibility at

the firm level, distortions in favor of more capital-intensive production techniques.

Tokman (1992): during the 1980s labor regulations accounted on average for a 20 percent increase in labor costs in a group of Latin American countries; fringe benefits and social security contributions.

High hiring and firing costs lead employers to hire less. opting instead for casual labor and temporary contracts.

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High mandatory severance payments as a contingent tax on labor use; tend to impede the speed of adjustment to adverse sectoral and aggregate shocks.

Fallon and Riverso (1989)

Labor as a quasi-fixed factor of production: Incidence of long-term unemployment increased

through reduced labor turnover. Regulations may reduce acquired skill-set of the

chronically unemployed and reduce the downward pressure exerted by the unemployed on wages.

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Negative reinforcement of labor regulations: high minimum wages and job protection legislation may together price unskilled workers out of new jobs and reducing incentives to invest in new skill acquisition.

Removing these provisions would then reduce nonwage labor costs and eliminate rigidities that impede labor mobility and the efficient allocation of resources.

View reconsidered: In industrial countries little empirical evidence that

employment protection measures cause unemployment persistence.

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Abraham and Houseman (1994): Germany, France, and Belgium in mid-1980s; no evidence that provisions affect speed of labor market adjustment.

Developing countries: poor compliance with existing regulations (Freeman, 1993) results in de facto flexible wages and little direct effect of job security provisions on employment.

Standing (1991) Benefits of employment security regulations:

improve workers' commitment to the enterprise and raise work motivation and productivity;

reduce employment transactions costs and labor turnover;

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improve job and work flexibility; willingness of workers to accept occupational and work environment changes;

induce workers to accept lower wage rises; reduce probability of frictional unemployment.

In emerging markets, a more balanced evaluation of employment protection regulations seems warranted.

1 chapter 14 structural adjustment: agriculture, trade, and the labor market © pierre-richard...

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