Who Says Labor Laws Are “Luxuries”?

By Servaas Storm, Senior Lecturer of Economics, Delft University of Technology, and ​Jeronim Capaldo, Research Fellow, Tufts University. Originally published at

A standard recommendation given to late-industrializing economies by the economic advisors of the World Bank and the International Monetary Fund has been to refrain from imposing regulations on the labor market, or if such regulations are already in place, to abolish them.

If you are a policymaker in a late-industrializing country, chances are you’ve been told that your problem, what is really holding your economy back, is excessive labor regulation – it is making your exports uncompetitive and chasing away capital. Laws “created to help workers often hurt them,” stated the 2008 World Bank’s Doing Business Report. To avoid any misunderstandings about the Bank’s reckoning with ten years of crises, the working draft of the 2019 edition advocates for cutting minimum wages, facilitating dismissals and removing other labor regulations in order to favor employment and economic development. The Washington-hired advisors, themselves enjoying many employment-related benefits, may have developing nations’ best interest on their mind. After all, the (enduring) Washington Consensus is clear: in developing countries as in all countries, minimum wages, employment protection, regulated working conditions and collective bargaining will prematurely raise labor costs harming businesses’ ability to compete on international markets. Exports will suffer, profits and investment will fall, and the very jobs these laws are designed to protect, formal-sector jobs, will be destroyed.

In this view, labor rights and labor protection are more likely to create additional unemployment and informal-sector under-employment, particularly of unskilled workers or labor force entrants, than lead to higher wages and better working conditions. Right? So, esteemed policymaker, what you should do is simple: reduce already existing employment protection, resist those siren’s calls to higher minimum wages, and curb regulation. Later, once your economy has developed, you can bring back some of those “European-style” luxuries. After all, they are good for social peace.

Well, this story is as wrong as it is ubiquitous. As it happens, it is mainly based on abstractions while more realistic reasoning and plenty of empirical analyses deny it support. And there’s more. As we discuss in our new INET working paper, there are many channels through which labor regulation supports capital accumulation, economic growth, employment creation and fairer income distribution.

To see why labor regulation does not hinder growth, even though it likely leads to higher labor costs, we can start from Thirlwall’s (1979) analysis in which a “small” developing country must export or attract capital in order to keep up purchases of critical imports. Appropriately extended, this analysis shows us that an increase of average wages (achieved, for example, by raising minimum wages or empowering wage claims through stronger protection) has three effects: a loss of competitiveness on world markets, an acceleration of productivity growth and an upgrading of the composition of exports. Overall, these effects are small and statistical findings suggest that their net impact on growth is either negligible or positive. But it’s useful to briefly consider them one by one.

A loss of (cost) competitiveness affects both exports and imports, with the net effect depending on how sensitive each of these flows are to cost increases. If the so-called Marshall-Lerner condition is satisfied, the net effect of higher wages and higher unit labor cost will be to drive down the economy’s external balance, thus depressing growth. In practice, however, this need not be a serious concern. On the one hand, by all indications, this effect will be small. On the other, empirical findings seem to indicate that the net effect of a cost increase on the external balance will be zero. In this case, the first of the three effects mentioned disappears – an utterly realistic outcome.

The effect on productivity growth occurs because a higher labor cost pushes firms to invest in labor-saving technologies. Research shows that higher costs force more efficient technologies on existing firms and drive those that do not meet the challenge out of business. This helps the economy gain competitiveness. If a wage increase drives up unit labor costs, a productivity increase will drive them down. Not even the Washington-hired advisors can deny that their high wages are good for their productivity.

Finally, a higher average wage pushes firms not only to adopt more efficient technology, but also to upgrade to productive sectors that enjoy more stable demand (i.e. more income-elastic and less price-sensitive) on world markets. This loosens the balance-of-payments constraint, allowing for higher growth and faster employment creation.

When put all together, these effects indicate that, in a late industrializing economy facing a balance-of-payments constraint, regulation resulting in higher wages either does not hinder growth or favors it.

The story doesn’t end here either. If we enter the realm of political economy, where income distribution is considered in its interplay with economic efficiency and political processes, we find three more channels through which stronger labor regulation supports development. First, strong labor regulation increases the legitimacy of industrial relations – an effect emphasized by mainstream scholars and policymakers – with positive impacts on productivity, competitiveness, growth and employment. Secondly, it is an opportunity for policymakers and other social groups to harness firms’ profit-making activities toward innovation. Last but not least, stronger regulation supports domestic demand by enhancing the labor income share (the flipside of real unit labor costs). Since dynamic domestic demand is a key driver of the division of labor, structural change, and industrial upgrading, this effect is critical in triggering the process of “cumulative causation” (to use Gunnar Myrdal’s classic expression) that fosters sustainable development.

Labor regulation certainly has many important social functions that transcend economics. Most importantly, it supports human rights and basic social processes. But there is also more to it in the economic sphere than is acknowledged in the standard narrative that sees it as a luxury developing countries cannot afford.

In light of our analysis, the options open to policymakers in late-industrializing countries look quite different than in the standard advice. Labor regulation is a powerful developmental tool to be deployed in sync with industrial policy and capital account regulation (the latter is needed to avoid capital flight or threats of capital flight neutralizing the labor regulation). Dispensing of strong labor regulation is the real luxury developing countries cannot afford.

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15 comments

  1. rd

    I think US tariffs should be based primarily on labor and environmental protection in the other countries. One of the reasons that those countries can take jobs from Americans is because compensating workers and protecting workers and the environment are minimized. so we are out-sourcing our pollution, poverty, and disabilities to those cheaper countries. That cost advantage should be eliminated through tariffs with reduction of tariffs as countries meet certain benchmarks.

    I have no problem in competing with other countries on an even playing field.

    1. lyman alpha blob

      The problem is that neoliberals want to have their cake and eat it to. Globalization is seen as a boon, and corporations want to exist in every country. If that is to be the case, it would seem to follow that we should eventually have one global currency and one wage system. But where’s the money in that? – no more currency or wage arbitrage. What fun is it if there’s nobody to exploit?

    2. Altandmain

      Yes, I agree that it should be a function of labor and environmental protection.

      Another consideration though must be that it should be based on nations that deliberately undervalue their currency or engage in efforts to undermine labor reforms.

      The real reason why you are never going to hear about it is because neoliberalism is just intellectual cover for the rich to loot society.

  2. Left in Wisconsin

    With regard specifically to late-industrializing countries, while I agree with the authors’ conclusion…

    Labor regulation is a powerful developmental tool to be deployed in sync with industrial policy and capital account regulation (the latter is needed to avoid capital flight or threats of capital flight neutralizing the labor regulation).

    … achieving synced labor reform, industrial policy and capital controls against unified employer (and IMF) opposition is a pretty tall order for most late developers.

  3. Synoia

    Later, once your economy has developed, you can bring back some of those “European-style” luxuries. After all, they are good for social peace.

    How’s that worked out in the “developed” economies? For example the UK and USA?

    The excuse is that “the developing countries don’t have expensive “labor luxuries” so we can’t be competitive, and have to demolish our protections.

    The EU also appears to be hot on the pursuit of demolishing “labor protections.”

    Something about “Equal protection for all crosses my mind.”

  4. lyman alpha blob

    I agree with the diagnosis of the problem, but the prescription is a little weak. The author argues that rising wages are OK because it will incentivize companies to look for labor savings technologies to increase productivity. Sure, having higher wages leads people to purchase more and thus increases corporate profits at least in theory. However if it’s only a small and shrinking portion of the population with a job that can afford to purchase anything, what happens to everybody else whose jobs were replaced by technology?

    And no, more tech jobs is not the answer, The more tech jobs we have, the more everyone forgets how to do anything themselves, leading to the crapification of everything. We are currently seeing this play out.

    We need a job guarantee and/or BIG and they we need to go artisanal as was discussed here recently. And the latter is going to happen whether we want it or not because neoliberalism looks to be pretty well played out.

  5. PKMKII

    The underlying assumption of the World Bank/IMF types that prevents them from considering the 2nd and 3rd effect of labor protection laws is that they think the only value in so-called developing economies is to act as dumb, cheap labor. Central America can’t improve their productivity, Africa can’t make better products, they can only be good at churning out cheap garbage for multinationals. Saying “you need to suppress labor costs” is just another way of saying, “we don’t think your labor has any substantial value.”

    1. hunkerdown

      It has great value and I think they’re aware of this. They’re just not willing to pay commensurate with that value. After all, someone’s got to the chickens for subsistence wages, in order for the First World to dine cheaply. This is the “wealth pump” in action.

    2. salvo

      exactly, that’s just hypocrisy, their are jsut hiding behind pseudo-science their their interest in keeping conditions in ‘developing countries’ favourable to explotation by ‘multi-nationals’,

  6. Stupendous Man - Defender of Liberty, Foe of Tyranny

    Having not read this piece I’m “flying blind” here, but still willing to take a shot at an answer to the question posed.

    I suggest it is capital, and/or capitalists.

  7. Steven Greenberg

    In discussions with a friend of mine from India, I finally came to the conclusion that the workers in each country should have a say in what labor laws they want to see in their own country. It is unfair of us to insist on our labor standards in other countries. Workers in other countries could conclude that trying to impose our standards on them is just an excuse for preventing our jobs to go to their workers. So let the workers in these countries decide if they think it is to their advantage to have jobs at the wages and working conditions that would prevail in their countries if they had labor laws to their liking.

    You can have all the economic theory you want, but democracy might be the more important principle. Not our style democracy, but whatever style of democracy that suits the people in their own country.

    1. d

      Well the problem with that of course, is even in a democracy,the ‘workers’ wont get there way, the same reason we dont, business and the top .01% will get their way. been that way for a long time in almost all countries even when its their bottom line. which it does

  8. Scott1

    The Washington Consensus is by another name “Privatization”. The Russian people knew what was being done to their nation by Yeltsin who bought what Washington Wall Street financial engineers were selling.

    The result of the purchase by Yeltsin of the Privatization agenda has ben Oligarchy. Russians had already gone through hell as their nation collapsed. The forces of greed as enabled by the Washington Consensus triumphed only because there was revolution fatigue.

    If there is a progression of capitalism, communist capitalism as in China and Russia sure appears to suck for those who are either born into lives as labor, or as in the case of the American pushed out of the middle class into the precariate.

    In mature industries that make things the professional will seek to hire professionals or create within their industry a professional labor pool.

    This will happen regardless of whatever venal and stupid political ideology adopted by the rulers. Hollywood producers employing expensive talent hire union labor because professional labor is much less likely to contribute to death and dismemberment of the cast or crew.

    The pool of competent pilots in the US was so diminished that there was a significant fatal crash and the hours required to become a professional airline pilot went from something like 250 hours to around 1500 hours.

    American Airlines now has their own flight schools.

    “If you think a professional is expensive, wait till you hire an amateur.” is the truth, has been the truth, and will be the truth.

    Thanks.

  9. /lars

    IMF and WB “recommendations” have nothing to do with achieving general prosperity for countries populations. It’s all about who shall have power and control. A continuation of 4 decades of counter revolution on 20th century democratization revolution. Especially the economic democracy.
    It definitely has nothing at all to do with science (economic), its solely about power struggle and stripping labor and general population of power. You can prove as much as you want that applied economic models are unrealistic, it won’t achieve an iota. Revolutions are not made by scientific research papers, revolutions are made by people that are prepared to shed blood literary or imaginary.

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