After the debt crises in the 1980s many countries made deep pro-market reforms in LAC, yet few and timid reforms were done in the labor market. Even though per capita GDP  growth in Latin America was extremely low during the 1980s (an average annual rate of -0.9 percent) compared to OECD countries (where the annual rate was around 2 percent), LAC employment grew by a healthy 29 percent during the whole period (WDI 2009). The high level of inflation and informality seemed to “grease” labor markets and therefore limitations in these markets did not seem to be an obstacle to reap the benefits of other structural reforms, like trade liberalization. At the time it was not seen as necessary to spend scarce political capital on labor market reforms.

Once sound macroeconomic policies were in place and most countries opened their economies, labor market issues did eventually raise obstacles for future growth: low human capital, almost null training, lack of flexibility in formal labor markets, dual labor markets, etc. (See for example World Development Indicators 2009; Doing Bussines, World Bank 2010). But the momentum for pro-market reforms had waned. Lack of transparency in some reforms, particularly in regard to privatization, and poor performance in labor markets reduced public support for pro-market reforms. The "Washington Consensus" became a bad word in Latin American politics (Williamson 2004). The lack of public support and the opposition of unions, which mainly represented public sector workers and employees from large and regulated firms, blocked any attempt to extend reforms to labor markets (Madrid 2003).

Why the labor market was not a political/policy concern during the 1980s and beginning of the 1990s?

In addition to high inflation, the higher level of informality and lack of rule of law in many countries made labor markets in LAC, de facto, flexible in the 1980s.² Therefore they did not seem to require reform in the short and medium term. Trade, fiscal and financial reforms required a lot of political capital to be implemented, therefore there were neither political power nor the necessity to implement labor reforms which could have created unrest among organized workers. Thereafter, in the 1990s, there came the economic necessity to implement labor market reforms but, as we show in the next subsection, the initial pro-market momentum was by then extinguished.

Why after privatization, trade openness and financial liberalization we do not observe important labor reforms in LAC?

We argue that there are three main reasons for the lack of labor reform in the post “Washington Consensus” period. First, there has been a rising opposition to pro-market reforms. During the 1990s, inflation could no longer “grease” labor markets. At the time when labor market restriction became binding in some countries, the “Washington Consensus” paradigm became unpopular. Pro-market reform in general, and in particular labor market reforms did not have the needed political support any more.

Second, the shadow economy creates certain dynamics in the political economy of labor reform. As mentioned for the "Washington Consensus" period, informality may have played an important role providing flexibility to the labor market during the 1990s. The steady increase in informality may have been the reaction of Latin American economies to increasing volatility in an environment of low inflation and high labor market regulation. Once high regulation became more binding and no reform emerged, firms reacted to this new instable environment by increasing informal contracts, leaving out a large number of workers from the political economy process. In short, this generated a vicious cycle which will be described in more detail below. Third, the economic boom during the 2000s reduced pressure to reform labor markets and informality.

Insider-Outsider Workers, Job Benefits, Unions and Informality: A Vicious Circle

Most economists agree that highly regulated labor markets promote informality (see Loayza et al. 2005, Johnson et al. 2008, IDB 2004). As labor regulations increase, the opportunity costs of formal employment rise. In a context of weak enforcement, the costs for firms to remain completely or partially informal may be much lower than the costs of formal compliance. Enforcement is not applied equally to all firms. As pointed by Loayza et al. (2005), strict regulations are more likely to be enforced in large firms and particularly in large foreign corporations. 

In practice, this equilibrium implies an inefficient allocation of resources and less protection for workers. Firms with a lower probability of being inspected or that use bribes to avoid regulations have lower costs, not because they are more efficient but because they have a “privilege.” In the end, few workers benefit from the “protection” provided by stringent regulations.

As pointed by Schneider and Karcher (2010), the characteristics of labor markets in LAC reinforce this equilibrium. First, the firms’ possibility of using flexible, informal employment mutes business opposition to high levels of regulation. Although businessmen favor more flexible employment protection laws, the presence of informal employment within the firms and through subcontractors reduces the costs of employment protection laws and the incentive to push for reform. Meanwhile, given that enforcement is more likely for foreign firms, local businesses that take illegal advantage of informality have a regulatory competitive advantage.

Second, government and policy makers, knowing that the regulatory burden is too high and therefore reduces economic activity and employment, do not have huge incentives to enforce stringent labor market regulations.Third, the informal economy grew during the first half of the 1990s because institutions of labor law enforcement were dismantled to relieve pressure on firms. Value added tax (VAT) evasions during economic downturn might be evidence in the same line.

Fourth, the proportion of organized workers is low and they have low power to define labor relationships. Unions are small, they exist mainly in large firms, lack plant level representation, and union confederations are politicized (See Schneider and Karcher 2010). This is not surprising because in Latin America workers in the public sector have disproportionally high unionization rates and its labor relations are usually more politicized and influenced by legal developments since the employer is the state (Freeman 1986). Large informal sectors reinforce the small size of unions and encourage them to focus on the narrow "insider" interests of workers in the formal and public sector.

Lacking leverage in direct negotiations with employers, unions invested heavily in ties to the state and political parties to promote extensive protective labor codes and wage setting mechanisms that favored them but was detrimental for labor as a whole.³ High minimum wages with low level of enforcement in LAC and high level of severance payments serve as examples (IDB 2004).  

In sum, the potential coalition to reform the informal sector and labor regulations is weak. Informal workers are not organized, unions are small and belong mainly to the public sector, and businesses may avoid regulation through informality.  Moreover, strict labor regulations become a competitive advantage for those who abuse of informality and, therefore, reduce the pressure for reforms.

References

Freeman, Richard B. (1986) "Unionism Comes to the Public Sector," Journal of Economic Literature, American Economic Association, vol. 24(1), pages 41-86, March.

IDB (2004) "Good Jobs Wanted" IPES, Economic and Social Progress Report, Inter American Development Bank, Washington DC.

Johnson, Simon, Daniel Kaufmann, Pablo Zoido-Lobatón (2008) “ Regulatory Discretion and the Unofficial Economy”. The American Economic Review, Vol. 88, No. 2, Papers and Proceedings of the Hundred and Tenth Annual Meeting of the American Economic Association (May, 1998), pp. 387-392.

Loayza, N., A.M. Oviedo and L. Servén. (2005) “The Impact of Regulation of Growth and Informality. Cross-Country Evidence,” World Bank Development Policy Working Paper WPS3623.
Madrid, Raul (2003). ‘‘Labouring Against Neoliberalism: Unions and Patterns of Reform in Latin America.’’ Journal of Latin American Studies 35:53–88.

Schneider, B. and S. Karcher (2010) "Complementarities and Continuities in the Political Economy of Labor  Markets in Latin America" Socio-Economic Review, Vol. 8, 4.

Williamson, J. (2004) “A Short History of the Washington Consensus”. Paper commissioned by Fundación CIDOB for a conference “From the Washington Consensus towards a new Global Governance,” Barcelona, September 24–25.

¹ This paper is based on the chapter “Labor Market in Latin America and the Caribbean: The Missing Reform" In Javier Santiso and Jeff Dayton-Johnson, eds., Latin American Political Economy. Oxford: Oxford University Press, forthcoming. We thank Andres Gomez-Lobo. We also acknowledge the funding provided by the Millennium Scientific Initiative "Microdata Center" Project P07S-023-F. 
² Caballero et al. (2004a) show that employment protection laws reduce job reallocation, although this effect is statistically and economically significant in countries with high rule of law. Micco and Pages (2006), using a completely different approach, find similar results.
³ Murillo and Schrank (2005) and Cook (2007) claim that this political focus has often been effective in maintaining high labor regulations.