Regional Perspectives on World Development Report 1995 -
LABOR AND ECONOMIC REFORMS
IN LATIN AMERICA AND
THE CARIBBEAN






Regional Perspectives on World Development Report 1995
LABOR AND ECONOMIC REFORMS
IN LATIN AMERICA AND
THE CARIBBEAN
THE WORLD BANK
WASHINGTON, D.C.



İD 1995 The International Bank for Reconstruction and Development / The World Bank
1818 H Street, N. W, Washington, D.C 20433, U.S.A.
All rights reserved
Manufactured in the United States ofAmerica
FirstprintingAugust 1995
This report has been prepared by the staff of the Workl Bank. The judgments expressed do not
necessarily reflect the views of the Board of Executive Directors or the governments they represent.
Editing, layout, andproduction by American Writing Corporation
ISBN 0-8213-3348-8
ISSN 1020-3648



Contents
Foreword v
1 Policy Background 1
Reforms in the 1980s 1
Poverty and income distribution 1
2 Labor Market Conditions 3
Demographics and labor supply 3
Employment, unemployment, and real wages 5
T he special case of Caribbean countries 7
Changing labor market conditions in Latin America, 1960-95  7
3 Policy Reforms and International Integration 10
Trade reform 11
The real exchange rate and capital inflows 11
Broadly based reforms: The key to success 12
International migration 14
4 Current Labor Market Interventions and the Road to Reform 16
A role for governments in setting wages? 16
Dealing with wrongful dismissals 16
Contributions to social security 18
Labor-management relations  19
5 The Changing Role of the State 23
Public secror employment and wages 23
Setting priorities and choosing better policy instruments 23
6 The Outlook for Workers 25
References 27
iii



This report was prepared in conjunction with World Development Report 1995:
Workers in an Integrating World. It was written by Alejandra Cox Edwards under the
direction of Michael Walton and in close collaboration with the Latin America and
the Caribbean Regional Office. This collaboration was coordinated by Suman Bery.
Meta de Coquereaumont and Paul Holtz edited the report. Christian Perez laid out
the text.
Ian Bannon, Daniel Cotlear, Sebastian Edwards, Edgardo Favaro, Norman Hicks,
Homi Kharas, Danny Leipziger, Luis Londono, Raj Nalari, and Roberto Steiner
revised and commented on eatlier drafts. Louise Cord, Geoffrey Shepherd, and
Mateen Thobani helped draft Box 2. Many other professionals from the Latin
America and the Caribbean Region helped with case studies, country reports, and
other background materials. Luis Riveros (University of Chile) also commented on
an earlier draft.
iv



Foreword
ver the past decade most countries in the Latin        The recent shift toward marker orientation and openness to
( )  America and Caribbean Region have stabilized their  international trade requires a different approach to labor policy
economies and lowered barriers to international trade.   and different instruments for addressing income distribution
These efforts, which have been rewarded by the restoration of   goals. Labor policy has to be redirected toward enhancing
positive economic growth, are ultimately driven by the need to   employment opportunities and labor productivity throughout
advance in the fight against poverty, which is the majoreconomic   the economy. Market-based growth that makes efficient use of
challenge facing the region. Although the reform process itself  labor increases opportunities for all workers to better themselves.
may sometimes produce transitory dislocations, deeper engage-   But an unequal distribution of initial endowments (including
ment with the world economy is the best assurance of rising liv-   access to effective education as well as physical assets) tends to
ing standards and reduced inequality for all. For countries in the   perpetuate differences in income distribution across generations.
region, the reform imperative is both strengthened and compli-   To change these patterns, Latin American countries have to find
cated by certain characteristics: an urbanized population, heav-   ways to improve this initial distribution by promoting access to
ily dependent on informal rather than formal sector activity; high    education and targeting the delivery of services to the poor.
payroll taxes, with their associated disincentive effects; consider-   Deepening reform, including social sector and labor policy
able inequality in education levels; and sizable social security   reform, holds out the hope of large improvements in the incomes
financing needs, stemming from the relatively advanced stage of   and working conditions of most ofthe region's workers and a nar-
several countries in the demographic transition. These factors,   rowing of differentials between rich and poor.
which diminish the impact of reforms already taken co improve   This report gives special attention to four areas of labor pol-
the living conditions of the population, need attention if the full  icy. First, direct government intervention in wage determination
benefits of liberalization are to be captured.               and strict seniority rules have to give way to a system that rewards
The goal of establishing an environment for market-based    effort, high productivity, and good management within a frame-
economic growth grounded in each country's comparative    work that relies on voluntary negotiation of working conditions
advantage represents a major departure from the past, when    between workers and firms. Second, job security legislation has
direct price interventions were used to address poverty goals and   to be replaced by a more effective mechanism that protects work-
import substitution was used to promote industrialization.   ers when they change jobs. Third, mandatory contributions to
Investments undertaken in these distorted economic environ-   social security and other programs must be designed carefully in
ments yielded only low rates of total factor productivity growth,   order to minimize the distortionarv effect of labor taxes. Fourth,
diminishing the capacity to increase per capita incomes.   government subsidies for training and education must be redi-
Governments attempted to make up for the failure of markets by   rected to the demand side and targeted to those who cannot
increasing public sector production, but that ultimately com-   afford to pay.
promised macroeconomic balance and resulted in inflation and    Given a deepening both of engagement in the international
recurrent balance of payment crises.                         economy and of internal reform, the countries of Latin America
Many of the policies aimed at reducing poverty and tackling   and the Caribbean have the potential for more rapid growth.
inequality in the 1960-80 period-including agrarian reforms,   fuller involvement of labor in the economic mainstream, and
minimum wage legislation, and labor market regulations-were   substantial poverty reduction in the years ahead.
well intentioned, but the region made little or no progress in
improving income distribution. Furthermore, such policies dis-
couraged the effective use of the most abundant resources of the
region, including labor. Labor policy was seen as a means of
directly enhancing workers' well-being through government
involvement in wage determination and mandates on fringe ben-                       ('
efits and job security. At best, these attempts improved the con-        Shahid Javed Burki
ditions and security of the minority of formal sector workers, but       Vice President
they added a bias against overall labor demand.                          Latin America and the Caribbean Region
v






CHAPTER I
Policy Background
WorUDeT Tore lopment Report l995examines the relations   economic growth. This improvement in aggregate indicators is
between policy, economic performance, and the   an important step in reducing poverty and reversing decades of
Vi'  well-being of workers. It concludes that there is no    deplorable social conditions. The structural reforms started dur-
more powerful mechanism to raise the incomes of workers than   ing the last decade can be sustained only by reducing poverty and
market-led development. Integration with the world economy    increasing the equality of income distribution. Attending to the
creates tremendous opportunities for countries that manage their   needs of the poor for education, nutrition, and health will have
domestic economies soundly. A market-based strategy requires   important direct effects on economic growth as a larger propor-
public action that enhances the functioning of markets, particu-   tion of the population acquires basic human capital, growth
larly the labor market-and that has important implications for   should accelerate.
the selection of instruments of social policy. Transitions to more
market-oriented systems inevitably generate winners and losers.   Refonns in the 1980s
Transfer programs, reforms to promote labor mobility, and poli-   After more than three decades of inward-oriented policies and
cies to equip workers for change are all necessary to increase adapt-   heavy state intervention, Latin American countries initiated a
ability and spread the benefits of fiuture growth.           series of market-oriented reforms in the 1 980s to achieve macro-
These lessons are important for Latin American countries,   economic stability and reestablish economic growth. Govern-
which pursued industrialization based on import substitution    ments imposed budgetary discipline in the public sector, in some
and suffered frequent macroeconomic imbalances from  the   cases by privatizing state enterprises; reduced international trade
1950s through the 1970s. As a consequence they failed to estab-   barriers and realigned exchange rates; and deregulated financial
lish an environment conducive to sustained growth in labor pro-   markets (World Bank 1993b). These reforms are changing the
ductivity. Overvaluacion  of the real exchange  rate hurt   role of the state as it pulls back as a producer of goods and ser-
labor-intensive exports and agriculture, with detrimental conse-   vices and reduces its intervention in the setting of prices and allo-
quences for employment and wages, while inflation hit the poor   cation of investment. Somewhat surprisingly, these reforms have
particularly hard because they have fewer defenses against the   barely affected labor markets in most Latin American countries.
direct and indirect consequences of the inflation tax. Analysis of  It is now apparent that fiscal discipline, removal of trade bar-
the structural transformation of the region between 1950 and    riers, and financial deregulation are not enough to encourage the
1980 reveals less reliance on exports than expected, investment   private sector to invest and create jobs, at least not quickly enough
at about the expected rate, and more rapid contraction in agri-  to reduce poverty and build support for market-oriented policies.
cultural employment than expected (Syrquin 1991). At the same    In addition, governments need to do better in their traditional
time governments tried to improve workers' welfare through    role of providing public goods (basic infrastructure, police pro-
interventions in wage determination and collective bargaining   tection). And they need to find new instruments of social policy
and through legislation on fringe benefits and job security.  that do not distort (or that minimize distortions in) the allocation
Market-oriented reforms have attempted to correct the biases   of resources. This requires reforming tax policies, public funding
that these policies introduced. In the process the role of the state   for education, social security systems, subsidized housing, and
is slowly being redefined. Some countries substantially reduced    more. These reforms must reduce the distortions that persist in
effective rates of protection to industrial activities and reestab-   theseeconomies while preservingsocial goals-improvingthe liv-
lished incentives for nontraditional export activities. But other   ing standards and economic opportunities of the poor.
areas of policymaking still need attention, including labor pol-
icy, public sector employment, property rights, and the provision    Poverty and income distribution
of public goods and services. Despite considerable variation    Poverty and inequality have long plagued Latin American
within the region, there are clear patterns of labor policy that   economies. Between 1950 and the late 1970s the share of income
need revision, along with public sector employment and pay    going to the poorest fifth of the population generally declined.
polices that influence the functioning of the public sector.  Although economic growth between 1960 and 1980 improved
Since the mid-1980s many Latin American countries have   living standards-as measured by school enrollments, health
improved their macroeconomic stability and begun to restore   conditions, nutrition levels, and other social indicators-by the



L A, ra o R   A N D            D c o ND o  M I C  r  F     R M S
Table 1. Population below the poverty line in selected
Latin American countries, 1970 and 1981                    Table 2. Social indicators, 1970, 1980, 1990
(percent)                                                  (weighted averages)
Country                   1970                 1981        Indicator                   1970        1980       1990
Argentina                   8                     8        Illiterate population
Brazil                     49                   43          (percentage of population
Chile                      17                   16          aged 15 or older)          29.0        23.0       15.3
Colombia                   45                   43         Enrollment ratios,
Costa Rica                 24                   22          ages 6-11                  71.0        82.3       87.3
Honduras                   65                   64
Mexico                     34                   29         Gross enrollment ratios,
Panama                     39                   37          secondary level            31.6        47.4       54.9
Peru                       50                   49         Population per physician   2,053       1,315      1,083
Venezuela                  25                   24
Average for ten Latin                                      Percentage of population
American countries        39                   35with access to safe water            53.7        70.1       79.8
Infant mortality rate
Source: World Bank 1993b.                                   (per 1,000 live births)    84.9        63.0       48.2
Life expectancy at birth
early 1980s a large portion of the region's population still lived    (years)          60.1        64.3       67.5
in poverty (Table 1).                                      Note: Includes data for countries with populations above 1 million.
Growth almost always reduces poverty, as demonstrated by   Source: World Bank 1993b.
Brazil, Colombia, Costa Rica, and Mexico during the 1970s.
Morley (1992) calculates that as per capita income grew 41 per-   market-oriented policies, labor-intensive activities expanded, and
cent in Costa Rica between 1961 and 1971, poverty was cut in   the accumulation offactors thatcomplement laboryielded higher
half. Similarly, the region's declining incomes in the 1980s were   returns. Rural employment increased substantially, lifting rural
associated with a rise in the extent and severity of poverty.  incomes. Rapidly growing demand for labor in urban markets
Yet many social indicators-infant mortality, school enroll-   allowed wages to rise, and the poor shared in rising living stan-
ment, life expectancy-have continued to improve despite the   dards. Investment in human capital-especially at the preschool
rise in poverty (Table 2). Although it is believed that publicly pro-   and primary levels-helped increase productivity and real wage
vided services have declined substantially because of the large   growth and reduced inequality (World Bank 1995). The higher
budget cuts, the overall expenditure probably has not been   wages induced further productivity increases throughout the
reduced by much-and may have remained unchanged (Grosh   economy and fed back into the growth process.
1992). The lag between budget cuts and measurable change in   This report examines key aspects of labor market conditions,
social indicators may be one reason for the continued improve-   on the supply and demand side, as they are affected by the reform
ment in these indicators. Another may be that aggregate trends   process that is integrating Latin American economies with world
hide worsening conditions in some parts of society. It is also pos-   markets. Four areas are highlighted in which labor policy has
sible that social spending has become more efficient.      made a difference and reforms can benefit growth and improve
East Asia's experience demonstrates how sustainable economic   outcomes for workers. Issues of transition and the challenges fac-
growth reduces poverty through many channels, including   ing countries in the region in reforming their social delivery sys-
employment creation and rising real wages. As the region adopted   tems are also explored.
2



CHAPTER 2
Labor Market Conditions
D        uring 1965-93 the working-age population grew by     Demographic trends affectgrowth in school-age populations,
about 3 percent a year in all developing regions. This  labor force participation, and old-age dependency (ratio of the
consistent growth stands in sharp contrast to the large   elderly to the working-age population). There are close links
differences in GDP and productivity growth across developing   between population age structure and labor supply, as is illus-
regions. Annual GDP growth in East Asia, for example, reached   trated by the cases of Brazil, Guatemala, and Mexico, which have
7.5 percent, in Latin America and the Caribbean it was 4.1 per-   different population age structures (Figure 1).
cent, and in Sub-Saharan Africa it was less than 3 percent. The  Except for the young and old age groups, labor force par-
evidence indicates that economic growth is not constrained on   ticipation rates for men within age groups change little across
the supply side. Sustained growth is possible through the efficient   countries and over time. But for women they increase as fertil-
use of natural endowments and the accumulation of comple-   ity falls. A country's overall rate of participation is the result of
mentary resources. The challenge facing Latin America and the   interactions between individual behavior (participation) and
Caribbean is to establish an environment that makes efficient use   demographics (age distribution of the population). For exam-
of the region's resources and expands demand for labor.    ple, Brazil, which has a higher life expectancy than its neigh-
There are a number of ways to look at labor market condi-   bors, tends to support a large share of the elderly out of the
tions. Workers are concerned with jobs and compensation levels.  labor force.
They make decisions about labor force participation based on
labor market conditions and other variables that affect their costs   Working-age population and labor force participation
of living. Employers are concerned about worker availability and   The working-age population (those between fifteen and sixty-
reliability, as well as labor costs. Their hiring decisions are also   five years old) grew by about 3 percent a year between 1965 and
influenced by market prices and macroeconomic conditions. For   1993, and is now estimated at about 300 million. The labor force
policymakers, rising real wages are often cause for concern, since   participation rate (those of working age who are working or seek-
they may signal a loss in competitiveness; declining real wages are   ing employment) is estimated to be 56 percent. or nearly 165
also reason for concern because they represent a worsening situ-   million. While the growth rate of the working-age population
ation for workers. To be useful as indicators of performance,   over the past three decades was comparable to that of other devel-
labor market indicators must be examined along with other varn-   oping regions, the labor force grew faster than in other regions
ables. For example, it matters whether changes in real wages are   (except for the Middle East and North Africa), fueled mostly by
related to labor productivity, affect all workers, or reflect market   the rising participation of women as fertility rates deciined and
forces or policy interventions.                            female schooling levels rose. Like other regions. Latin America
saw a decline in participation among the very young-as school-
Demographics and labor supply                              ing increased-and the very old (see Figure 1).
Population growth rates have been falling throughout Latin    Labor force participation rates for women have increased
America, dropping from 2 percent a year in the late 1980s to a   from an average of 28 percent in the 1970s to 38 percent in the
projected 1.6 percent for the late I 990s. The region is in a late   early 1 990s. There are large variations across countries, with the
stageofthedemographictransition, when concerns begin toshift  rate ranging from a low of 24 percent in Bolivia (1989) to a high
from schooling facilities to care of the elderly. Still, there are   of 51 percent in El Salvador (1990). No direct linkexists between
important variations in patterns of population growth. In some   economic development and women's labor force participation.
countries, mostly in Central America, populations are still grow-   Still, rapid development is often accompanied by higher female
ing rapidly, a result of high fertility. Population growth results   participation, higher levels of schooling for girls, and lower fer-
from the interaction of behavioral variables (fertility) and demo-   tility rates. Labor market conditions matter too. In El Salvador,
graphics (the age distribution of the population). For example,   for example, military conflict and migration reduced the domes-
Brazil has a lower fertility rate than Mexico, but because the share   tic supply of male labor, inducing the entry of women into the
of women of reproductive age is larger in Brazil, the population   labor force. T he regional economic downturn of the 1980s also
growth rate is higher in Brazil (2.1 percent) than in Mexico (1.9   had an impact on women's participation, which tends to rise with
percent).                                                  recessions in low-income countries.
3



L A S r R  AN N D   E c D 1 O M I C  R EF a R M S
Figure 1. Population and labor force by age and gender in Brazil, Guatemala, and Mexico, 1965 and 1995
(millions)
Brazil 1965                                                      Brazil 1995
[EU                           65 plus
[f]                           60-64                            rEc
1E 1                          55-59
50-54
45-49
40-44
35-39
30-34
men                women                 25-29                men                       women
20-24
15-§19
10-14
0-9                                _ _ _ _ _ _ _ _ _ _ _ _ _ _
20    15    10    5       0      5     10    15    20            20    15    10    5        0     5      10    15    20
Guatemala 1965                                                   Guatemala 1995
65 plus
60-64
55-59
50-54                            EA I
45-49
L] H40-44
[2 _                           35-39
F D1                           30 34                          lm2gxs |33
men       E D      women                 25-29                   men                 women
13 D 202-24
15-19               1 
10-14
0-9    ,   _ ,    _,      _,
2     1.5    1    0.5    0    0.5      1     1.5    2            2     1.5    1    0.5    0    0.5      1    1.5    2
Mexico 1965                                                      Mexico 1995
65 plus
60-64                             m
55-59
50-54
E: 1                          45-49
40-44
35-39
30-34
men                women                 25-29                   men          s       women
IES L:                         20-24
E1                               15-19
10-14         1
0-9         1     -
15      10        5       0          5       10       15         15       10       5        0       5        10       15
F  Population             E   Labor force
Source: ILO estimates and projections.
Rising level of schooling                                          differences in secondary schooling were already negligible in
Primary schooling reached 100 percent coverage in most Latin    the 1970s.
American and Caribbean countries in the 1970s, although               While Latin American and Caribbean countries have made
secondary-level coverage continued to show large disparities    considerable progress in providing education, other regions have
across countries, ranging from  8 percent in Guatemala and    done as well or better. In 1985 countries in Latin America and the
Haiti to 70 percent in Barbados. Secondary schooling has since    Caribbean and those in EastAsia had about the same share of pop-
expanded rapidly, and by 1990 coverage rates had doubled in    ulation with some schooling (Figure 3). EastAsia had a larger pro-
most countries. Exceptions include El Salvador-where sec-    portion of population with secondary schooling or more, while
ondary coverage remains under 30 percent-and  Brazil-    Latin America and the Caribbean had a higher proportion with
where it reached only 40 percent, a low rate for a country at its    higher education. Since then East Asia has increased both overall
income level (Figure 2). In contrast with other regions, gender    enrollments and the share of students with secondary or more
4



L A B O R  N1i A R KCET  C ON 1 D I T IO r N S
schooling faster than Latin America and the Caribbean, though
Secondary school coverage expanded in the                  it still trails in higher education coverage. Note that overall edu-
1970s and 1980s                                            cation levels change slowly, despite significant advances in cover-
age. That is because investment is concentrated among the young,
Figure 2. Secondary school coverage in Latin                  while the distribution takes into account the entire population.
America and the Caribbean, 1970-90                            The relative performance of schooling investment in Latin
(percent)                                                     America and the Caribbean is heavily influenced by Brazil, which
o     20     40    60    80   ioo              represents a third of the region's population.
Barbados          ___________. __- 
Trinidad                ''                             Employment, unemployment, and real wages
Uruguay                      =                        Formal employment is an important fraction of the labor force.
Chile_
Argentina   =- - - - -fi_                              The Economic Commission  for Latin America and  the
Dominican Rep.                 .                            Caribbean estimates that in 1990 employers, employees in firms
Peru                                               with more than five employees, professionals, and the public sec-
Guyana                    i''                        tot accounted for 43 percent of the urban labor force in Bolivia,
Panama               [-  i:                           54 percent in Brazil, 60 percent in Chile and Panama, and nearly
Venezuela                                               70 percent in Costa Rica and Venezuela. Public sector employ-
Ecuador        e- . e    '                            es make up a large share of formal employees: 37 percent in
Colombia    ___                                        Venezuela, 42 percent in Costa Rica, and 50 percent in Panama.
Mexico              --a                              Regionwide, 52 percent of employment is generated in the ser-
Nicaragua |                                             vices sector, 26 percent in industry, and 22 percent in agriculture.
Costa Rica _ X--__ °i_              . i 1970            Central American countries are less urbanized (about 40 percent)
Bolivia                          L_ 1985             and more agrarian than South American countries, where close
onrazi                             1990             to 80 percent of the population lives in urban areas (Table 3).
Paraguay                                                  The rural economy is receiving considerable attention in
El Salvador j    111                                     Latin American countries, after years of neglect. Recent reforms
Guatemala    E                                           have given a boost to agriculture, which had been burdened bv
Haiti                                              years of macroeconomic instability, real exchange rate overvalu-
Source: World Bank 1993a.                                    ation, and import substitution to promote industrialization.
(East Asia's more balanced policy toward agriculture, by contrast,
East Asia has overtaken Latin America and the Caribbean in schooling coverage
Figure 3. Education levels in Latin America and the Caribbean and East Asia, 1985-95
(percent)
100 rW                                                           100 K
I           Rising stock of schooling                                           Rising stock of schooling
80 r      in Latin America and the Caribbean                     80 r                  in East Asia
60 (                                     .?                      60           
401                          ,'˘';tR';.               l---1985   60 V
40                                        ''    '40
_ !  ?  s ?', .  .  *1995                                _     -   
20  _-                      ? -  -  ?  c  ' . ' -'  ' ';         20                              - _
0                                                                                        o
H,gher    Secondarv    Some                   Some                Higher    Secondar    secondary    Prar mar
Highrce  Shoand  Fm  secondary    Pri9ary     primary
Source: Ahuja and Filmer 1995.
5



L . A 1    a  r    A.4        E  D    r-  c  o  M  I c    F2 E  FI    O  r  M  S
Table 3. Urban and rural employment in selected countries, 1990
(percent)
Urban employment                                Rural employment
Pnvate sector
employers,                      Self-
Urban      professionals,                  employed,
popu-        and firms                    small firms,
lation     with more than                and domestic                   Wage        Self-employed   Self-employed
Country     (share)     five employees    Public sector   servants    Employers  employees           farmn         nonfarm
Venezuela    84             45.6             22.5         31.9            6.9        46.2            33.1           13.2
Chile        81             59.4                          40.6            2.9        64.7            25.1            7.2
Brazil       76             54.0                          46.0           3.1         42.5            45.6            8.8
Panama       70             32.6             29.3         38.1           2.0         38.9            47.3           11.8
Costa Rica   46             42.5             25.0         32.5            5.1         66.3           16.8           11.8
Guatemala   38              31.3             14.6         54.1           0.5          38.3           47.9           13.2
Honduras     35             30.1             14.8         55.1           0.5          33.9           48.7           17.2
a. Included under private sector.
Source: CEPAL 1992.
encouraged the development of productive rural nonfarm activ-    explain the incidence of urban informality: a pro-industry, anti-
ities. A recent World Bank study found that the likelihood of   agriculture bias, which encouraged faster rural-urban migration
rural poverty in Ecuador falls significantly with increases in per   than in other regions, and labor policies that overlooked the role
capita landholdings, years of schooling, and the proportion of   of wages and working conditions as incentives and market signals,
household members with a regular off-farm job.                   reducing the number of formal jobs and encouraging the devel-
In some countries nonfarm rural labor demand has arisen in    opment of the informal sector.
response to seasonal patterns, while in others it has been associ-
ated with booms in the processing of local raw materials. In many
countries workers move back and forth between rural and urban      =         _
areas, working in rural areas in peak seasons and as urban street
vendors in the slack season. As a result, a large degree of season-    Figure 4. Regional patterns of urban informality
ality in the production of coffee or sugar can be accommodated    (percent)
by worker movements. Recognizing the importance of this             Informal sector
mobility in the design of labor legislation can be an important   share of labor force
K Sub-Saharan Africa
step toward increasing overall efficiency, improving labor pro-     80 -                            El East Asia and the Pacific
ductivity, and generating better opportunities. In a number of                                      E South Asia
countries labor legislation works against this pattern of rural-    70 -Burkina Faso                  Latin America and
urban movement rather than supporting it. Temporary formal                                             t
60 -x S>l Peru
contracts are restricted in duration and renewability, hourly con-
tracts are often restricted, and benefits required by law assume    50       °Senegal
the existence of a long-term contract.
In all economies there is a continuum of employment oppor-       40                    *               Mexico
tunities, from self-employment within the household to formal                Pakistan C Malaysia
employment in registered enterprises. Informal activities are cho-  30                                  Argentina
sen as a way of avoiding taxation. The urban labor force working    20 L                       .
in the informal sector is as high as 75 percent in some developing
countries (Burkina Faso. Sierra Leone). Informaliryand labor pro-   °0
ductivity are negatively related. Holding GDP per worker con-          0          2.000       4,000        6.000        8,000
stant, the incidence of informality is highest in Latin America and      GDP per worker (dollars: 1985 international prices)
the Caribbean (Figure 4). Two policy-related factors help to      Source: Banerji 1995; Summers and Heston 1991.
6



L.A 9 B O R  M A R K E T  CO N D I T I OCN 5t
Social security systems with weak links between benefits and    up (Figure 5). Countries that introduced economic reforms began
mandated contributions encourage workers to avoid the payroll  to recover in the 1 990s (Chile, Argentina), while those that did
tax by working in the unregulated informal sector. A study of the    not continued to lag (Brazil and others). Is the recovery sustain-
Brazilian social security system found that workers stay in the    able? The answer depends on whether reforms are continued, par-
informal sector as long as possible, switching to formal employ-   ticularly at the microeconomic level. Domestic macroeconomic
ment only to meet the vesting requirements of the pension sys-   policies and external conditions also will have important impacts.
tem. During the late 1 980s private sector workers in Peru began  The debt crisis, and the adjustment period that followed, hurt
to abandon wage employment contracts to become short-term    employment and real wages. Urban unemployment in the region
independent contractors, which allowed them to use the equiv-   typically rose in the early 1980s and declined thereafter (Table
alent of the mandatory 9 percent payroll contribution for pub-   4). Figures are hard to compare across countries (data come from
lic health insurance to buy private health insurance.          survey questionnaires), but some trends are apparent. Argentina,
Another reason that workers may stay in the informal sector   Nicaragua, and Peru have seen unemployment rise in the 1990s,
is that, where promotions are based on seniority, formal employ-   while in Bolivia, Chile, Colombia, Guatemala, and Venezuela it
ment may not reward entrepreneurship, initiative, or individual   has fallen.
effort. A study comparing the informal sectors in El Salvador,    In Argentina and some other countries unemployment is
Mexico, and Peru found that wages were higher in the informal   closely linked to economic restructuring and sectoral shifts.
sector than in the formal sector in Mexico, suggesting that   Pessino and Giacchini (1994) find evidence of an increasing
Mexican workers may be paying for the stability and pre-   duration of unemployment. This finding suggests that, at least
dictability of formal jobs by accepting lower wages.          for some of the unemployed, the gap between their supply price
Three types of policies should guide government responses to   and market wages has risen, making them less likely to accept
informal labor markets. First, antilabor biases, whether against   job offers. This may reflect changes in the market value of some
agricultural or formal sector employment, should be removed.   skills, which is consistent with economic restructuring, and the
Second, the tax and regulatory burden on formal activity should   introduction of unemployment benefits.
be set at moderate, enforceable levels. Third, there is scope for
public action, especially in urban infrastructure provision. Policies  Latin America saw labor productivity fall
that subsidize credit for some farms over others should be avoided  during the debt crisis
as well. Small firms see lack of credit as a constraint, but the expe-
riences of East Asian countries and, more recently, Bolivia show  r
that small firms can develop despite real interest rates on the order  gr  5 reg     dfensint   g
of 40 percent-as long as they have access to credit and markets.    per worker, 1965-93
Price stability seems to be the necessary condition for credit to         -8  -6  -4  -2   0   2   4   6   8  10
spread to the small firms and farms sector (Mosley 1993).                  r                          196180    1
East Asia and the Pacific     1980-90
The special case of Caribbean countries                                                                         1990 93
The Caribbean countries, with a population of 20 million in                Europe and Central Asia
1992, represent about 5 percent of the region's total population.
This area contains the richest country of the region in terms of                                   l
GNP-the Bahamas-and the poorest-Guyana and Haiti. As              Latin America and the Caribbean
a group these countries differ significantly from the rest of Latin
America. The Caribbean countries have high trade-to-output          Middle East and North Africa
ratios. The most open countries have trade ratios that exceed 80
percent, and even the least open (Haiti) has a trade ratio of more
than 25 percent. As a result these economies often experience                  H,gh-inconneOECD 
large external shocks.
South Asia
Changing labor market conditions in Latin America,
1960-95
Output and labor productivity grew adequately in the region                 subsaharanAfrica
between 1965 and 1980, but the debt crisis of the 1 980s marked
the beginning of a sharp downturn as international credit dried    Source: World Bank data and estimates.
7



L A 6 OR r A^N D  E C ONO  0 M I C  R E F O R M S
Table 4. Average annual urban unemployment in selected Latin American countries, 1984-94
(percent)
Country              1984    1985    1986    1987    1988    1989    1990    1991    1992    1993   1994a
Argentina             4.6      6.1     5.6      5.9     6.3      7.6     7.5      6.5     7.0      9.6    11.2
Bolivia               6.9      5.8     7.0      7.2    11.6    10.2      9.5      7.3     5.8      5.4     5.8
Brazil                7.1      5.3     3.6      3.7     3.8      3.3     4.3      4.8     5.8      5.3     5.5
Chile                18.5    17.0    13.1    11.9    10.2        7.2     6.5      7.3     4.9      4.0     6.2
Colombia             13.4    14.1    13.0    11.8    11.2        9.9    10.2    10.2    10.2       8.7     9.3
Costa Rica            6.6      6.7     6.7      5.9     6.3      3.7     5.4      6.0     4.3      4.0
Ecuador              10.5    10.4    10.7       7.2     7.4      7.9     6.1      8.5     8.9      8.9     8.1
Guatemala             9.1    12.0    14.0    11.4       8.8      6.2     6.4      6.7     6.1      5.5
Honduras             10.7    11.7    12.1    11.4       8.7      7.2     7.8      7.4     6.0      5.9
Mexico                5.7      4.4     4.3      3.9     3.5      2.9     2.9      2.7     2.8      3.4     3.7
Panama               12.4    15.7    12.7    14.1    21.1    20.4    20.0    16.1    14.2    12.5    12.0
Paraguay              7.3      5.1     6.1      5.5     4.7      6.1     6.6      5.1     5.3      5.1     5.1
Peru                  8.9    10.1      5.4      4.8     7.9      7.9     8.3      5.9     9.4      9.9     9.5
Uruguay              14.0    13.1    10.7       9.3     9.1      8.6     9.3     8.9      9.0      8.4     9.0
Venezuela            14.3    14.3    12.1       9.9     7.9      9.7    10.5    10.1      8.0      6.6     8.9
.. Not available.
a. Preliminary.
Source: CEPAL, Economic Survey of Latin America, various issues.
The resumption of growth in Latin America has generally   The challenge ofpoverty alleviation
brought a recovery in real wages, although in Argentina, Peru,   Access to basic education, rural and urban infrastructure, and
and Uruguay real wages in 1993 were still below their 1980 lev-   public goods affects the capacity of households and individu-
els (Table 5). In some countries higher levels of schooling have   als to perform in the market economy. Thus the government's
contributed to higher wages. In Argentina, Brazil, Chile, and   role in opening up market opportunities for all citizens is
Mexico market-oriented reforms and trade liberalization have   increasingly important. It is also essential that the social pro-
been accompanied by increases in the relative wages of workers   grams that accompany market-oriented reforms be designed to
with more schooling. Data for Colombia and Costa Rica sug-   spread economic opportunities, especially among the poor
gest that other factors also play a role in boosting real wages.    (Box 1).
I  I     *   I                      --IS-.
Table 5. Average real wages in selected Latin American countries, 1984-94
(1980=100)
Country             1984    1985    1986    1987    1988    1989    1990    1931    1992    1993   1994a
Argentina           116.9   106.1   107.5    96.9    93.7    75.8    79.4    80.5    81.6    80.3    85.7
Brazil
Rio de Janeiro        ..       ..  122.9   101.5   105.7   108.2    87.0    92.2   115.3   119.5   109.2
Sao Paulo          105.1   111.8   137.3   127.7   138.3   149.1   130.8   125.4   138.1   151.9   162.7
Chile                97.2    93.5    95.1    94.7   101.0   103.0   104.8   110.1   115.1   118.6   124.6
Colombia            118.1   114.6   120.1   119.2   117.7   119.5   116.0   115.3   117.3   122.8   122.2
Costa Rica           84.7    92.2    98.0    88.5    84.5    85.1    86.5    82.5    85.9    94.7
Mexico               74.8    75.9    73.2    72.0    71.3    77.8    79.4    84.7    92.9   100.2
Peru                 87.2    77.6   101.1   108.9    82.1    44.8    39.1    42.1    41.6    41.3    47.4
Uruguay              72.2    67.3    71.7    75.0    76.0    75.8    70.4    73.0    74.6    78.2    79.2
.. Not available.
a. Preliminary
Source: CEPAL, Economic Survey of Latin America, various issues.
8



L AS rs o R   M A R K E-T  C O NI D I T I ON S 5
Box 1. Reaching out to the poor
An important survival strategy for poor families is to increase
the number of household members working to support the       Poverty is high among indigenous groups
group, including children. Child labor remains prevalent in
Latin America despite legal restrictions. In Brazil, for exatnple,
it is estimated that about 18 percent of children between the   Box Table 1. Poverty among indigenous and
ages of ten and fourteen work The incidence of child labor is   nonindigenous groups
high among low-income families and among poor female-   (percentage below poverty line)
headed households. But it is also high where the demand for   coutsy        I    _mhn;          Nonindigaious
child labor is high and the quality and availability of school-
ing are low. Enforcement of labor regulations may eliminate   Bolivia         64.3                  48.1
1. 1 l  1  . s     .   .   r              ~~Guatemala          86.6                 53.9
child labor, but it also may worsen the situation of some poor   Mexico       80.6                  17.9
farnilies. Reaching our to the poor to increase their opportu-   Peru         79.0                  49.7
nities in the market economy requires a comprehensive
approach that takes into consideration the interaction
between labor market conditions, schooling availability, child   formal schooling and health care. Projects to ease the isola-
labor, and poverty.                                      tion and deprivation of indigenous people can benefit from
Poverty also manifests itself in street children-typically   their participation in the design and implementation.
teenagers-in many countries. Recent studies in Brazil        Addressing these diverse social policy matters requires a
found that street children differ from working children in    multifaceted approach that combines legislation and specific
several ways. They typically have broken off ties with their   programs with the participation of nongovernmental orga-
farnilies, particularly their fathers. They also tend to have   nizations and other civic groups. Several countries in Latin
behavioral problems, to have dropped out of school, and to   America have begun to recognize the merits of targeting and
be addicted to drugs. For years nongovernmental and reli-   of decentralized programs. This approach recognizes the
gious institutions have been reaching out to these children,   advantage of funding private solutions to constantly chang-
providing shelter, basic needs, and schooling. Preventive   ing social problems. The effectiveness of the approach rests
action is considered most effective in keeping children off   on the division of responsibilities: while private organiza-
the streets.                                             tions focus on problem solving, the public sector pays atten-
Poverty is pervasive and severe in Latin America's indige-   tion to measurable results and cost-effectiveness.
nous population (see Box Table 1). Poor indigenous groups
tend to be concentrated in rural areas, isolated by bad roads   Source. Psacharopoulos and Patrinos 1994; World Bank data;
and lack of communications, and to have limited access to    Vial and Valde 1994.
A number of countries in the region are moving in this direc-   obligations, and so on) for all workers. Such burdensome require-
tion. A renewed interest in increasing enrollments, especially at   ments discourage formal labor contracts, leaving informal work-
the primary level, explains recent reforms from Argentina to   ers with no legal protection. The requirements also constrain
Nicaragua. Correcting problems in land markets is part of the pol-  formal employment creation and have negative effects on the use
icy agenda in Colombia, Ecuador, and Peru and was central to   of labor. As the dynamic theory of labor demand emphasizes. hir-
agriculture's recovery in Chile in the 1 980s. Yet in most countries   ing and firing decisions have three distinct characteristics: they
the formal labor market still is not open to active participation    entail sunk costs, they take place in an uncertain environment,
and negotiated wages, working conditions, and collective con-   and they need to allow  for some flexibility  in timing
tracts. For example, hourly contracts are not permitted under   (Hamermesh 1993). Onerous job security regulations and an
Ecuadorian legislation, leaving a large number of workers in the   unpredictable system of worker representation and dispute reso-
informal sector.                                            lution add uncertainty to estimates of labor costs. This uncer-
tainty has a direct negative impact on employment levels, as well
The link between labor policy and labor demand              as on the speed of adjustment (Dertouzos and Karoly 1992).
Current labor legislation in many countries determines not only    Reforms should aim at establishing basic rights, reducing distor-
basic legal rights, but also detailed conditions of the labor con-   tions and uncertainty, and enhancing the incentives for private
tract (wages, job security, number of vacation days. employer   employers to create formal sector jobs.
9



A                 I
Policy Reforms and
International Integration
I  nternational trade offers opportunities for efficient special-   country takes will depend on its initial endowments and strate-
ization but also brings new risks. How can the region avoid   gic choices. As real wages rise, all countries see a shift from agri-
the exchange rate volatility of the past? The answer lies in   culture and  primary  production  to  manufacturing  and
strengthening the domestic economy and expanding the role and    services-first labor-intensive goods and then increasingly skill-
efficiency of factor markets.                               intensive products. But countries that are richer in natural
The debt crisis made countries in Latin America and the   resources will remain net exporters of primary products longer:
Caribbean review their economic policies and consider more   they will have to attain higher levels of skills and of capital per
seriously the advantages of an export orientation. But it took   worker before they start to specialize in manufactures. Many
some time for policy reforms to be implemented. On the exter-   countries in Latin America will likely follow such a path. The
nal front terms of trade deteriorated and economic activity in   experience of more industrialized countries shows that even
industrial countries slowed in the late 1980s. But Latin American    where natural resources are abundant, production patterns
and Caribbean countries were able to borrow at low real interest   change, particularly in the use of labor. This is mainly a reflection
rates, and growth returned to the region in the 1990s. The com-   of the required balance between rising real wages and rising labor
bination of easy finance and tough competition in international   productivity. As the newly industrialized economies of East Asia
goods markets represented a danger for some countries. For
example, in countries other than Brazil output grew by more
than 15 percent during 1990-94; as a result, investment and con-
sumption grew sharply and net exports deteriorated in relative                         _
terms. Current account deficits grew despite export expansion in
most countries because imports increased even more. Exports    Figure 6. Real wages and exports in developing
and growth have not always been positively correlated. In    countries, 1975-93
Argentina and Paraguay export volumes fell despite substantial  Average growth in
economic growth. In Brazil and much of the Caribbean eco-     manufacturing real wages
nomic growth has been substantially slower than export growth.  0.12 -
International trade brings immediate gains through cheaper  0.10                       i
imports and long-term gains as resources are used more effi-
0.08 
ciently. Workers can take advantage of better job opportunities
as the economy grows. In fact, during the past two decades real  0.06
wages rose at an average annual rate of 3 percent in developing
counrries where the growth of trade (exports as a share of GNP)  0.04
was above average, but stagnated in countries where trade      0.02
expanded least (Figure 6). This correlation does not necessarily
mean that increased exports are a sufficient condition for faster  0                                  - - - ------
economic growth, but it does suggest that they are part of the  o002
story. Trade brings mutual gains to all countries, but it can also
have important distributional effects within national boundaries,  -0.04-
benefiting workers whose products are more in demand and      _0.06    _                *                   .  i
hurting others who lose out to new competitors.                  -0.08 -0.06  -0.04  0.02   0   0.02  0.04  0.06  0.08
Countries pursuing an export-led growth strategy will be                   Average growth in export-GNP ratio
induced to specialize in differenr ways. The growth path that each    Source: World Bank estimates.
10



r-  L I C Y r2 r EF O R M5  AN .4D  IN C           T1 " r r  N A T I ON 1A L I N Trs EG R A TIO 1N
show, countries that are able to expand domestic capacity by
investing in human and physical capital are better prepared to  Tariffs are falling in the region
adopt new technologies when market conditions are appropriate.
Trade reform                                                 Table 6. The opening of Latin America, selected
Trade reform                                 ~~~~~~~~countries and years, 198 5-92
Tariff reduction has proceeded rapidly in many Latin American    c  t)
and Caribbean countries, but it is still at a relatively early stage for   (percent)
most of the countries (Table 6). It is therefore premature to assess               Average tariff    Average coverage
the impact of reforms on growth or labor demand. Still, some con-                   pocn            of 1985r7 1991-92
clusions can be reached. If we group countries according to the                                         -      -9
classification in Table 6 and estimate average labor productivity   Early reformers
Bolivia             20.0      8.0       25.0      0.0
growth, we find that the early reformers outperformed all other   Chile          36.0     11.0       10.1      0.0
groups in the 1 980s and early 1 990s (Table 7). We also note that   Recent reformers
average productivity growth among recent reformers has been    Costa Rica        92.0     16.0         0.8     0.0
negaeThis result is driven by Mexico, where a elabor pro-   Mexico       34.0      4.0       12.7    20.0
negative, Thls result Is drlven by Mexlc  where average labor pro-   Uruguay     32.0    12.0        14.1      0.0
ductivity fell atan annual rateof 1.6 percent in the 1980sand con-   Very recent reformers
tinued to fall at an annual rate of 0.75 percent in the early 1990s.   Argentina  28.0    15.0       31.9      8.0
Brazil              80.0     21.1       35.3    10.0
Greater exposure to international markets brings new oppor-   Cm I  bia       830       6          3.3      1.0
tunities for private investors and major changes in the way busi-   Ecuador     58.0   .180          59.3       .0
ness is conducted. Attention to timing, quality, and reliability    Guatemala    50.0     19.0         7.4     6.0
becomes critical. The exposure to more competition and to inter-   Nicaragua     54.0                27.8
Paraguay            71.7     16.0        9.9      0.0
national trade is helping to improve labor-management relations.   Peru          64.0     15.0       53.4      0.0
It is now clear that there is no fixed amount of "rents" to fight for   Venezuela  30.0   17.0       44.1      5.0
and that workers and employers are better off working together   Not available
for a more successful enterprise. But industrial relations are very   a. Average total charges (tariffs plus paratariffs), unweighted.
much influenced by the methods of the past and by a legal frame-   b. Unweighted.
work that discourages cooperation between managers and work-   Source: World bank data; Erzan and others 1989.
ers. Such legislation requires reform.
The real exchange rate and capital inflows                      Early reformers outperform others
After the major effort associated with tariff reductions and the
difficulties brought about by large devaluations in the early stages   ThbIe 7 Annual rate of growth in labor produ y  y
of reform, a number of countries have allowed their real exchange     group, 1965-94
rate to appreciate substantially. Changes in domestic policy and    (percent)
international market conditions have brought large flows of cap-
Country group             1965-80     1980-90    1990 94
ital into the region in the 1990s. But the real exchange rate appre-   C
ciation has hurt exports and employment creation.            Early reformers             1.38       -0.12        4.12
Real exchange rates in most countries have appreciated by 10    Recent reformers     2.72       -1.55      -0.51
Very recent reformers       3.41       -1.20       0.71
to 30 percent since 1990. There is a strong correlation between    Nonreformers          2.49       -1.37        0.01
currency appreciation, capital inflows, and current account   Total                      3.09       -1.24        0.56
deficits. Adjusted for inflation, capital flows to the region were   Note: Weighted averages based on population in 1995.
larger in 1992 and 1993 than they had been at their peak dur-   Source: World Bank data and estimates.
ing the 1970s. The surge was also much more abrupt. Evidence
from  ten countries indicates that external factors played an    and Reinhart (1993) found remarkable similarities in the rela-
important role in the recent episode, which means that capital   tive size of capital inflows between ten Latin American countries
inflows are less likely to persist.                          (Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico,
Peru, Uruguay, and Venezuela) and eight Asian economies
Using capita/flows most effectively                         (Indonesia, Malaysia, the Philippines. the Republic of Korea,
Latin America has not been the only region to receive sizable   Singapore, Sri Lanka, Taiwan (China), and Thailand). Capital
capital inflows in recent years. A study by Calvo, Leiderman.   account inflows amount to 3.3 percent of GDP in the Latin
11



L A ES O R  AN N D   E 3C DN     M I C  R E F U R- M 
American countries and 2.7 percent of GDP in the Asian    advantageofchangesinmarketconditionsbyswitchingemploy-
countries. Across countries and regions there is a marked    menr, selling and buying assets, and starting new activities.
increase in international reserves. In the early stages of the cap-   Economic adjustment can also go faster if firms make decisions
ital inflows there were sharp increases in stock prices, and in both    about location, activity, and use of factors that respond to the
regions capital inflows have been accompanied by accelerated    economy's comparative advantages. An efficient response by agri-
economic growth.                                               culture to the new opportunities brought about by trade reforms
What distinguished the Latin American countries from Asia   rests on a functioning land market (Box 2). In countries such as
was the degree of appreciation in the real exchange rate and the    El Salvador and Nicaragua revolution and war have generated
savings response to the capital inflows. While the Asian countries   disputes over property rights, and governments are only begin-
increased their savings ratio by 3 percentage points, the Latin    ning to address the problem. Land markets in Latin American
American countries, on average, reduced it. Yet the causal rela-   and Caribbean countries are notoriously repressed and often dis-
tion between domestic consumption and the real exchange rate   torted. In some cases a substantial amount of land is held in large,
is not clear. The Asian countries were more aggressive in steriliz-   capital-intensive farms that employ very little labor, but that gain
ing capital inflows to limit monetary growth. Asian countries also   from credit and other subsidies. Half-hearred land reforms that
received a larger share of capital inflows in the form of foreign    sought or threatened to give land rights to tenants only sharp-
direct investment, which makes sterilization less important since   ened landowners' bias toward labor-saving production practices.
there is less volatility associated with those flows. The optimal   In Colombia, for example, potential crop land is used for ranch-
policy response to capital inflows depends on their anticipated    ing because policy biases favor large farms.
persistence and the nature of domestic credit markets. If capital
inflows are easily reversible, the conservative approach is to ster-   Broadly based reforns: The key to success
ilize 100 percent of the inflows. That is what Indonesia did to    Successful reformers such as Chile and New Zealand have
maintain macroeconomic stability during the oil boom. The aim    demonstrated that the best response to the opportunities offered
is to avoid a situation where real exchange rate appreciation hurts   by trade liberalization is a broadly based approach. In Chile
the export sector and leads to unsustainable current account   reforms introduced in the mid-1970s have focused on enhanc-
deficits, or where a sudden reversal of capital inflows leads to a    ing the role of the private sector in a market-based approach to
domestic financial crisis.                                     economic development. Policymakers' short-term prioriry was to
reestablish macroeconomic stability, whicih required reducing a
Labor market effects                                          substantial public deficit. The long-term goal was to reestablish
Real exchange rate appreciations represent an increase in real   the economy's growth potential, which required eliminating
wages relative to tradable goods-an increase that can be sus-   gross distortions in the allocation of resources. The first stage of
tained only if real incomes are rising. Policymakers are often    policy reforms included freeing retail prices, lifting interest rate
tempted to ride on the popularity of a real exchange rate appre-   controls, regularizing public sector accounts, introducing better
ciation, especially when they believe that they can take correc-   tax monitoring systems, establishing financial discipline, priva-
rive action later. But real exchange rate appreciations also reduce   tizing state-owned enterprises, and reducing import barriers.
the international competitiveness of exports. Where the exports   The second phase of reforms redefined the role of the state
sector is small, policymakers may avoid hearing these com-   and its interaction wich the private sector. The "seven modern-
plaints. Yet evidence shows that the cycles generated by real   izations" included labor law, social security law, educarion, health
exchange rate instability create enormous dislocations in the    services, land and water rights, judicial reform, and administra-
economy, particularly in the labor market. These cycles are par-   tive reform. The result was a modern regulatory framework that
ticularly dangerous in countries that are emerging from years of   guarantees free entry and property rights and that expands the
failed policies. Mexico's recent experience with capital outflows    realm of possible transactions. For example, land could be rented,
indicates that there are important lessons to be learned with   leased, divided, bought, and sold, increasing opportunities for
respect to monetary management.                                landowners and the value of land. In the social sectors careful tar-
But much more is going on as well. There are still major prob-   geting and decentralization constituted an extraondinarily com-
lems with the operation of land and water markers, with labor   plex institutional, administrative, and political task. Programs
management techniques, and with a tax system that continues to    were restructured, complex legal issues were addressed, and
subsidize certain sectors. To avoid large swings in the real   opposition from those who had benefited from previous systen
exchange rate, the domestic economy must be strengthened,   subsidies had to be overcome.
especially  through  better functioning  of factor markets.       In the early 1980s the Chilean economy suffered a major
Economic adjustment can occur faster if individuals can take    setback. In circumstances remarkably similar to the Mexican
12



P O  L I C Y   R E F O  R M S   AN " D   I N TE E- R N A T I ON 1  A  L  I  N TEr   B R A T I  O 13N
Box 2. Making the land market work: Reforms In Colombia, Ecuador, Mexico, and Peru
Limited rights over land, including the virtual abolition of   of land sales, defining water rights, and limiting the expro-
tenancy, explain to a large degree the lack of land improve-   priation of private land. A drive for the proper registration
ments and the low demand for agricultural labor in many   of land, combined with a reduction in agricultural subsi-
Latin American countries. Recent efforts to reverse these con-   dies that now favor large farmers, would have beneficial
straints have met with tremendous opposition and require a   effects for the poor.
good dose of political will.                               Under the 1969 Agrarian Reform, 85 percent of Peru's pri-
In Colombia a series of legalmeasures since the 1930s has   vately held rural land was converted into cooperatives.
had the effect of reducing incentives for large landowners to   Although former workers got the mandate to administer the
lease land to tenants. The right of landowners to employ   land themselves, they could not use it as collateral, rent it,
sharecroppers was formally outlawed in 1968. A steep fall in   transfer it, or sell it. These reforms inhibited investment, and
rural employment-3.9 percent a year-occurred between   agricultural production stagnated during the 1970s. While a
1970 and 1975. Throughout the 1 970s there was a wave of   1980 law broke up most of the cooperatives into individual
illegal occupations of farms, affecting 1,500 to 2,000 famns   landholdings, it was only in 1991 that restrictions on sale and
and roughly two-thirds of Colombia's departments. This  rental were removed and land could be used as collateral.
avenue for land acquisition was closed in 1988, and the poor  Peru also has implemented a new law that greatly facili-
began to occupy steep hills or marginal land at the edge of the   tates the registration of rural property that was held in coop-
rain forest. The limited opportunities for the poor to farm amr   eratives, and of urban land that had been "invaded" in
undermining the sustainabiity of farming for all and have   previous years. Peru has made notable efforts in recent years
incited rural violence.                                 to reestablish property rights and markets, but the process has
Colombia passed a new reform law in 1994 that is   been mired in politics, in particular the opposition of those
designed to increase the role of the market in transferring   who benefited from the rents generated under the old law
land to the rural poor. Eligible applicants will receive a sub-   governing registration.
sidy of 70 percent toward the purchase of a plot of land suf-  In 1915 the government of Mexico gave 80 percent of its
ficient to support a farm family; credit would be provided   agricultural land to <kiataios. Ejidos are made up of individ-
to cover the remaining 30 percent of the purchase price. It   ual allocations and communal lands intended for pasrure.
is intended that the beneficiaries of the subsidy will group   Land could not be used for sharecropping and could be passed
together in cooperatives to negotiate purchases from own-   on only to another member of the ejidatarios family. In 1992
ers of large holdings. The new program also gives title to   an amendment to the constitution.officially ended the restric-
established squatters located on frontier lands and intro-   tions on land use and distribution, and ejidaarias obtained
duces land improvement measures for indigenous commu-   more rights on their property. Sales, for example, are permit-
nities. This law is a step in the right direction, but it fails to   ted within the ejik, but sale to an outsider must be approved
reform the adverse tenancy restrictions.                by the community.
The recently passed (1994) Agricultural Law in
Ecuador defines the necessary framework for the proper   Source:.World Bank 1995; personal communications with M.
fiuictioning of the land market by increasing the flexibility   Thobani, G. Shepherd, and L Cord.
experience of the early 1 990s, large capital inflows found their   and encouraged investors to exercise their options. But it took
way into the Chilean banking system in the late 1970s, cre-   more than ten years for economic growth to catch up with the
ating a lending boom. Aggregate demand and real wages rose,   dynamics of labor supply. Reforms began in the mid- 1 970s, and
resulting in an unsustainable overvaluarion of the peso. The   unemployment stayed above 10 percent for the second half of
capital inflows stopped in 1982 at the onset of the debt cri-  the decade. In the early 1980s unemployment reached 20 per-
sis, and a large devaluation of the Chilean peso followed soon    cent. Mexico's recent experience with reversal of capital inflows
after. In the third phase of reforms Chile responded by   shows remarkable similarities. But assuming steady progress in
increasing the independence of monetary authorities, vesting   implementation of reforms, its recovery may be quicker because
in them responsibility for maintaining stability in the mone-   of concerted action by the international financial community.
tary aggregates.                                           Chile has experienced average annual growth of 7 percent since
The three waves of reforms reduced policy-induced uncer-   1987. Employment growth has been substantial (unemployment
tainry, increased competitive pressures on the investment side,  is down to 5 percent), and real wages have risen strongly.
13



LAB CO R  AN C)D   E C ON 1O1  M I C   R E FO R  1S o
1Box 3 Private sctor lnittiave and economic pollcy undamentals                                      ... . ..
In 1970 the spar  populated rgion o     m  in norithrn   investors brought new minuig technology and built infra-
Chile was hurRy a center oopportunity for workets.: Th   struture. Newroads in the mountains helpprivate miers
desertrego   4dahandfI ot empoent opis inthe   witttheit prospecting and contriute  the diversification
sKnodtnftbpperminingsectrand attracedturststoobserve   ofhe regionaleconomy.l Fish unloading iincreased from
the traditinal ways dof in     gold and silver miners in. 1,100tons in 1973 to 236,000 tons in 1986 as investment
~~~)M  : o   iE:; in CC  et    an   vr: rmnrs inr:
the unspoiled. mountains. Fishermen dared to take their smal   revitalized the coast. The increase in economic actmty more
boatsinto; the erraticsea for a limited cEatch. The majority of   than quadrupled commercial establshments, and hotels
the population was: concentrated in two cities, Copiapo and   and tourist facilities multiplied fifen times. While farmers
Vallenaz that had developed a reasonable commercial and ser-   concentrated on itrproving the quality of table grapes, the
vice economy,kbut which had experienced littlegrowth for:  unit cost of shiipping fell from US$9 per ton in 1980 to
manydecades. In the mid-1970s the landscapeof thregion   US$5.50 per ton in 1986. Kqeyto the improvements in the
ibegan to chag. Betweei 1973 and 1986 tie area planted   transportation sector were legal reforms that affected
withvineyars  utiplied by more than seventy iimes, thanks   emplovyment in; ports and entry to shipping and related
:t the ado pton   a t o    bs  o computerized drip   businesss. :
0  .9500 _04 ::     techi b7.ir  .w bac on compte               C s 0rrir7  : . i:-ir.: ...s 
irrigation. The expansion.of the fruit-packing industry fol-  The economic base of the region did not change because
loiwed SOOn afie creating a larg source of seasonal employ-   of a discovery. Theidesert, the sea, the minerals, and the
ment inthe industr/s refrigerated plants. By the late 1980s   irriganton technology could have been combined in pro-
laborers' was in Atacama's agricultural area of Copiapo were   duction before. Two elements prompted the transforma-
the highest in Chile, and thousands of people traveled fromn   tion in investors' behavior: better incentives to produce for
an                                                              or   i       7!:  ive 
other regions during the harvest season.                 the export market, and a set of legal reforms that clearly
Atacama's traditional sectors-mining and fishing-also:  delimited :public and private responsibilities, reducing the
experienced spectacular growth during this period. Foreign   uncertainty associated with economic policy.
Agriculture and mining have attracted significant investments,   in border areas (United States-Mexico, Venezuela-Colombia,
helped along by productivity improvements in transportation    Nicaragua-Costa Rica, Chile-Argentina), but it takes on greater
and communications, demonstrating that the opportunities   importance for the labor market of small economies, such as the
offered by international integration induce responses from all   Central American and Caribbean countries. A large portion of
sectors of an economy (Box 3).                              migratory flows is linked to seasonal agriculture, and the direc-
tion of the flows responds closely to the economic conditions in
International migration                                     each country. International migration and remittances provide a
While many countries have liberalized their trade, nearly all con-   stability cushion to the domestic economy. If a large share of the
tinue to manage migration, though the case for labor mobility   labor market is integrated with the labor market of other coun-
seems as compelling from an economic standpoint as the case for   tries, workers' supply price is less influenced by local conditions.
free trade. Managing migratory flows effectively is difficult   Therefore, understanding the determinants of real wages and
because restrictions on migration can create scarcity rents that   unemployment in such countries as Costa Rica, Jamaica,
encourage illegal flows (Box 4).                            Nicaragua, Panama, and other, smaller countries in the
International migration extends the market for some occu-   Caribbean requires a set of variables that goes beyond labor sup-
pations beyond national frontiers. This is particularly important   ply and demand in the domestic economies.
14



P O L I C Y   R E F OR  M S   AND   IN E       T E R N A T ION A  L  I N T E  G FE A T I O  N
Box 4. Seasonal Jobs + restricted access to temporary-immigrant visas = Illegal Immigration
For the first time in forty-eight years, the 1992 apple har-  The governments of the sending countries were heavily
vest work force in the Eastern Panhandle of West Virginia  involved in the early stages of this program, and the U.S. gov-
did not include workers brought in from Caribbean islands   ernrent took responsibility for ensuring transportation from
as nonimmigrant, temporary foreign workers. This was the   point of recruitment and back, a minimum wage, guaranteed
culmination of years of controversy over the employment of   employment for a number of months or a minimum subsis-
nonimmigrant workers not only in West Virginia but in  tence allowance, and free housing and medical care. But as
many parts of the United States.                     time went by agricultural employers estabLished direct con-
The official admnisson of temporary nonimmigrant agri-  tracts with foreign workers or labor contractors and paid the
cultural workers to the United States began about seventy-five   transportation costs themselves. Growers and the Department
years ago in response to fears of agricultural labor shortages   of Labor became at odds as their objectives grew ever further
brought about by the combination of World War I and   apart. Growers want to secure able and willing workers dur-
changes in immigration policy. Successive waves of immi-  ing the peak season, the Department of Labor wants to make
grant groups have met the labor needs offruit, vegetable, and   sure that this is not done against the interests of domestic
horticulturl specialty agriculture. The Bracero Program    workers. But whar happens when access to tempoary immi-
established forrnal temporary non-immigrant worker status   grant visas is limited?
for Mexican agricultural workers in the 1940s and stayed in  Because the certification process has been made more bur-
effect until 1964. All temporary nonimmigrant visas since   densome and litigation surrounding the use of foreign labor
then, referred to as H-2 visas, have been offered under the   in WestVirginia has mounted, growers have turned to the use
conditions of the 1952 Immigration Act.               of unauthorized workers. Heppel, Spano, and Torres (1993)
One of the largest programs under the H-2 provision has   found that manyJamaican workers in West Vrginia had pro-
admitted agricultural workers from the Caribbean islands-   visional work cards that were soon to expire. Workers with
the BWI prograrn. While the Bracero Program was inrended   these provisional cards were afraid to leave the United States
for western growers, the BWI program was used primarily  for fear of later being denied entry. Having established work
on the East Coast. Over the years, however, BWI workers  relationships, they are more likely to stay in the United States
have been employed in shade tobacco in Connecticut, truck   as illegal immigrants when the best option would be to return
farming in New Jersey, cherry picking in Wisconsin, sweet  to Jamaica for the off-season.
corn in Idaho, tomatoes in Indiana, asparagus in Illinois,
peas in California, sugar cane in Florida, and apple picking   Source: Heppel, Spano, and Torres 1993; Commission on
in eastern states.                                   Agricultural Workers 1992.
15



A                 I
Current Labor Market
Interventions and the
Road to Reform
L      abor policy includes government mandates on contribu-   responsibilities and how  their functions are delimited. In
tions to social security, support for the collection and   Mexico, for example, chapter 4 of the Federal Labor Law estab-
dissemination of information, special programs for   lishes that collective contracts must contain a structure of jobs
employment creation, subsidies for worker training, and more   according to seniority.
(Box 5). Labor market policy reforms can help to strengthen the  In a market-oriented economy, where employers are guided
domestic economy. Labor policy also establishes an enforcement   by cost-benefit considerations, workers cannot be paid above
framework for individual and collective labor contracts, along   their marginal contribution to production. Preestablished mini-
with basic labor standards. The law typically grants individual   mum wages will either be irrelevant (if workers' contribution is
workers conditional rights to form unions-conditions typi-   higher) or result in fewer jobs. More workers would then have to
cally include a minimum number of members or a minimum    be self-employed or find alternative work in the informal sector.
percentage of workers in a plant-and unions are granted con-   Worker power in wage determination does not typically increase
ditional rights to represent workers in collective bargaining.   as a result of legislated minimums or adjustments, but as a result
Employers' conditional obligations to bargain with unions are   of alternative job opportunities that allow individuals to choose.
also established.                                         The combination of rational macroeconomic policies and open
The most serious labor market distortions in Latin America   trade orientation promises economic recovery and increased
result from government intervention in setting wages; the high   labor demand, but labor policies do not leave enough room to
costs of dismissal, which reduce flexibility and make a firm's  establish efficient contracts (individual or collective). A reduction
restructuring difficult and slow; high payroll taxes, which reduce   of the government presence in wage determination is required.
formal employment and inhibit the international competitive-
ness of local firms; and the nature of labor-management relations,   Dealing with wrongful dismissals
which encourage confrontation and costly settlement procedures.   Latin American labor legislation has a long tradition of protect-
ing job security. Measures include severe limitations on tempo-
A role for governments in setting wages?                  rary hiring and substantial costs-in the form of severance
Government policy has affected wages through indexation-in    payments-for unjust dismissals. The labor market impact of
countries with a tradition of inflation-and minimum wages.   employment protection laws depends largely on how firms and
With few exceptions, minimum wages have declined through-   workers perceive them. If specific rules, such as severance pay-
out the region in the past few years and have largely become a   ments, are seen as a delayed payment scheme, their effects on hir-
nonbinding restriction. Ecuador sets basic wages for more than   ing and other decisions will be minimal. But most Latin
one hundred occupations. But given the components that are   American legislation that determines employer liability in cases
added to the basic salary, basic wages represent a small share of   of dismissal makes severance payments equivalent to a tax on dis-
the minimum monthly pay required by law. There have recently   missals, discourages voluntary quits, and has detrimental effects
been proposals to rationalize the minimum wage in Ecuador.   on labor-management relations.
This would be a step in the right direction.                 Most employment protection legislation in the region
In other countries seniority criteria dominate personnel man-   severely restricts temporary contracts and differentiates
agement. Rigid structures established in collective contracts   between severance payments for "justified" and "unjustified"
determine who is trained, promoted, and given management   dismissals (Table 8). Justified cases require serious misconduct
16



C U R R E N T  L AS B o R                     RAR K E T  I N TE  R V E N T I O N S
Box 5. Enforcement mechanisms for sovereign labor laws
With rising pressure for links between trade agreements and  ILO conventions encourage compliance with
labor practices, it has become increasingly important for   labor laws
developing countries to have clear and enforceable labor laws.
Labor conditions, like povcrty reduction and overall devel-    Box Figure 1. Average number of ILO
opment, are a legitimate area of international concern. Many    conventions in force
current labor laws grant privileges to a few at the expense of             0    2   40  60  SD  100  120
the many, In response to international pressure to deal with
social problems, developing countries must establish stan-     United States
dards that make sense fr their development levels and devise       East Asia
mechanisms for their implementation.                              South Asia
Following the signing of the North American Free Trade             Africa
Agreement (NAFTA) in 1994, the governments of Canada,                  East
the United States, and Mexico signed the North Arnerican     andNot Easti      _
Agreement on Labor Cooperation. This document estab-                 Europe
and Central Asia
lishes procedures for dealing with disputes that arise in the  Latin America
application of the labor laws of each of the three countries,  and the Caribbean
Differences in the interpretation of the laws will be taken to        OECD
a committee of experts, and ultimately to a panel of special-         Spain
ists, who will establish a plan of action. The parties are comn-
mitted to promoting a set of principles within each country's   have the right to provide information as well. In essence the
labor law.                                               ILO conventions apply international pressure for countries to
International labor conventions are adopted by the   abide by their own labor laws. While each country is sover-
International Labor Conference after consultation with   eign and can choose its own laws, there is generally a correla-
International Labour Organization (ILO) member coun-   tion between the text of a countrzs labor law and the ILO
tries. The International Labor Conference is attended by   conventions that that country has ratified and put in force,
delegations of government representatives, employers, and   The average number of conventions in force varies signifi-
employees representing each country.                     canty by region, the largest being in the member countries
When a member state ratifies a convention, it commits to   of the OECD (Box Figure 1).
reporting regularly on the application of the convention in
law and in practice. Employers and workers orgnizations,  Source: ILO 1994.
and for the most part exclude economic considerations such   factor. Because of this, hiring and firing decisions are subject to
as financial distress and increased foreign competition. In   delays and temporary contracts are informal.
other words, firms undergoing restructuring are penalized.     Reducing the payoffs associated with litigation and trans-
Mass dismissals often are contested in court. Another salient   forming severance payments into a deferred compensation
aspect of labor protection legislation is that severance pay-   scheme would greatly increase the efficiencv of Latin American
ments are directly related to the worker's tenure in the firm,   labor markets. Reducing litigation payoffs requires defining
typically in the form of a certain number of months' salary for   employer liabiliry in cases of dismissal for economic cause as well
each year of service.                                       as in cases of dismissal without "cause." Argentina and Chile have
Job protection legislation in many Latin American countries   allowed this distinction in their laws. Some countries have begun
is attempting to achieve two policy objectives-penalizing   to transform severance payment schemes into deferred compen-
wrongful dismissals and providing unemployment insurance-   sation plans. In Bolivia, for example, workers have access to the
with the same instrument. The problem is that neither objec-   same severance payment in all cases of separation (quits and lay-
tive is well served. Firms devise ways of reducing the costs of   offs) after five years on the job. Other countries, including Brazil,
mandated severance payments, and employees attempt to trans-   Colombia, and Peru, have replaced traditional severance pay
form voluntary quits into dismissals in order to receive sever-   arrangements with a time-of-service fund, which accumulates a
ance payments. The law has the effect of making labor a fixed   fraction of each employee's salary (8 percent in Brazil, 8.33
17



*_ Ak  s o3 R    Al 1s D)   F_ G  C  N  O3 M  I C    r2 e F O  FR MA s
Table 8. Job protection legislation in ten Latin American countries
Restrictions                                          Severance pay     Severance pay    Severance pay
on temporary      Probationary    Notice required     for justified     for unjustified  for dismissal caused
Country        contracts          period          before dismissal   dismissal'        dismissal         by economic factors
Argentina      2 years,           3 months        1-2 months         None              WTb               0.5[WT]b
nonrenewable
Bolivia        renewable          3 months        3 months           None                          WT
once
Brazil         2 years,           12 months       1 month            Fund                        1.4(fund)
nonrenewable
Chile          1 year,            12 months       1 month            None              1.2(WT)d.e        WTd
nonrenewable
Colombia       3 years,           2 months        45 days            Fund'                    Fund + (15 to
nonrenewable                                                                 40 days' wages)Tc
Ecuador        2 years,           3 months        1 month            0.25(WT) +        0.25(WT) + fund + 3W if T < 3
nonrenewable                                         fund                     WT if 3 < T < 25
Pension if T > 25
Mexico         No                 -               1 month            3W                     (20 days' wages)T
restrictions
Nicaragua      2 years,           12 months       1-2 months         WT                           2(WT)
nonrenewable
Peru           2 years,           3 months        -                  Fund                       Fund + WTI
nonrenewable
Venezuela      renewable          3 months        1-3 months         T(10 to 30 days'    2(10 to 30 days' wages)T
once                                                  wages)
Note: W represents a monthly wage. T represents years of tenure on the job.
a. The legislation generally lists a number of reasons that make a dismissal 'justified." These include serious misconduct
(absenteeism, drunkenness) but do not include technical requirements or economic factors.
b. The law establishes a maximum W.
c. A minimum severance payment equivalent to 45 days' wages is payable in case of dismissal.
d. The law establishes a maximum T.
e. The burden of proof is on the employer. Failure to prove allegations of just cause may increase the penalty by up to 50 percent
over the normal severance (WT).
percent in Peru) to be made available in case of separation ("jus-   America and the Caribbean were changed to defined contribu-
tified" layoffs and quits). In Chile workers can choose this type   tion funds, accessible in case of quits or layoffs, their economic
of arrangement rather than the traditional severance payment   effect would be virtually the same as that of the U.S. system.
after seven years on the job. Employers are required to deposit
one month's salary in a savings account in the employee's name.   Contributions to social security
A reformed system of severance payments provides insurance   In most Latin American countries employers are required to con-
for laid-off workers. A  national unemployment insurance   tribute to the social security system, which generally provides
scheme-for formal sector workers-would do the same. The    workers with pensions, health care, and accident insurance. Such
systems are of equal merit so long as each is financed by the    programs were very attractive in their early years, but as programs
potential beneficiaries. This is generally done through payroll   have aged some benefits have been rationed or eliminated. Until
taxes on formal sector workers. In the United States "experience   recently all formal sector business firms were required to con-
ratings" create a direct link between employers' contributions    tribute to the social security system, forcing users to rely on the
and the probability of unemployment. The practical implication    public system.
is that the unemployment insurance tax rate goes up for employ-   In terms of economic cost and equity, most social security
ers whose unemployment insurance reserve has been used up by    systems in the region have problems. First, most pension funds
their former employees. If severance payment systems in Latin   encourage early retirement, generating a serious economic burden
18



t u R r E N T  L. A, c o R   M A, R K E T  I N T ER R V E N T I 0N N S
if retirees are still in their most productive years. Second, pension    required by law. About two-thirds of the countries that have these
benefits are often unrelated to individual contributions to the sys-   systems operate them through a central public fund. Among the
tem. Higher-income individuals, in particular, often benefit out   countries that rely on private arrangements, about twenty-
of all proportion to their contributions. Third, social security sys-   including the United States-require employers to insure their
tems tend to encourage expensive health care services that empha-   employees against the risk of injury on the job. In about half of
size curative rather than preventive care. In most countries   these, only private insurance is available. In the rest, a public fund
contributions to the health component of the social security sys-   exists, but employers are allowed to opt out of the public system.
tem are independent of marital status, family size, and age.    The premiums charged by private or mutual insurance com-
Benefits, however, automatically extend to dependents. As the age   panies for work-injury protection vary according to the history
structure of the population has changed, the economically active   of accidents in different industries. Some countries (notably
population has become less willing to support these systems-as   Norway and Sweden) have eliminated the risk factor, and all
in Peru. Finally, the poor segments of society are often excluded    employers contribute to the program at the same rate. In most
from social security. In Brazil, for example, only 18 percent of the    Latin American and Caribbean countries safety standards are
poorest income groups-which account for more than 40 per-   often the responsibility of the ministry of labor. Risk premiums
cent of the population-are covered by social security.       are set by industry.
Whether levies such as social security contributions are per-  An alternative arrangement could provide benefits-in the
ceived as pure taxes or as delayed compensation depends on the   form of lower insurance premiums-to employers who comply
link between individual contributions and expected future ben-   with safety regulations. In most countries in the region these pre-
efits. In most Latin American countries social security benefits-    miums are determined by sector, meaning that, for example, all
pensions and health care provision-are unrelated to individual   construction companies pay the same amount for workers' acci-
contributions to the system. Mesa-Lago (1991) and Cox    dent insurance. Reforms can expand the role of specialized insur-
Edwards (1993) argue that this lack of balance causes people to   ers in the provision of such insurance. In Chile, for example, such
view contributions as a pure tax and benefits as entitlement (Box   specialized agencies are more knowledgeable about safe practices
6). Furthermore, the social securiry systems in many of these   and set insurance premiums according to safety standards.
countries are financially insolvent, imposing increasing costs on
the economy as a whole.                                      Labor-management relations
In addition to solvency problems, pay-as-you-go social secu-   Most labor legislation in Latin America predates the region's
rity systems distort labor markets because of the heavy burden of   recent market-oriented reforms and suffers from two deficien-
payroll taxes on formal sector firms. Basic pension benefits are   cies. First, most workers are not able to choose their representa-
extended to all retirees, while only a fraction of active labor force   tion in labor disputes, since the right to representation is assigned
participants contribute to the social security system. Uruguay's  to official unions by the government. This has stunted the devel-
system dependency rate (the ratio of pensioners to contributors)   opment of labor organizations, which need to adjust to a more
stands at 53 percent and its benefit ratio (average benefit over   demanding labor market. Second, collective bargaining is too cut
average wage) at 84 percent, while Brazil's ratio of retirees to   off from market forces. Except for Chile, where labor reform was
active labor force participants has risen from 10.4 percent in   implemented in the early 1980s, the process is similar across the
1965 to 16.1 percent in 1995. Thus social security reform is  region. Unions proposeacollectivecontract, andemployers must
urgent in such countries as Brazil and Uruguay. Almost all coun-   respond. The state is a part of the negotiations from the start, and
tries in the region would benefit from pension system reform    the final agreement applies to all workers represented.
while their systems are still solvent.                          The case of autoworkers negotiating with General Motors in
There are several reforms that could improve the efficiency of   Brazil in April 1995 is representative. When negotiations
social security systems. Pay-as-you-go schemes with no link    between management and the union broke down, the case was
between contributions and benefits should be replaced by a com-   mediated by a labor court, which had to make a judgment and
bination of individual accounts and minimum benefits ensured   recommend a pay increase. This is a case of "interest" arbitration,
by the government (World Bank 1994). This type of system has   whereby the arbitrator determines the terms and conditions of a
been used in Chile since the early 1980s and is being imple-   new collective agreement. Court rulings are bound by labor
mented in Argentina, Colombia, Mexico, and Peru.             statutes and, often, by constitutional rights over aspects of the
Programs that provide compensation  for work-related   labor contract.
injuries and occupational illnesses have a long tradition. The two  Strikes traditionally have been allowed as an expression of
basic types of systems are social insurance systems that use a cen-   political pressure-albeit with an economic impact on individual
tral public fund and various private arrangements that are   firms. In theory each party should have something to lose dur-
19



L.AS CO R  AN D  E C ON O 0 M I C  R Ea FO R M S
Box 6.' 1Payroll taxes and their Impact on workers
Taxes on labor distort the: allocation of resources beause hey    payroll taxes4are paid over a lifeBime ofwork Pension levels. are
reduce h vaiilue of working time relatve to leisure, iincrease    based on ihe contibutions made in the five years before retire-
: :the  t: f: la              co : o pr6dii:  Th :.                 ES        onie
the cost of labor and increased the cost of production.They. ment. Workers do not conside their monthly contributions
also have distributional effects since paYll taxes and revenue   to the social securit system as tipart of their compensation.
benefits are likely to fall unevenly on different income groups.   Relative to a no-tax situaton s tax raises the cost of labor
Payioll taxes are tpicallyt high in industrial countnes, partic-   Wit employers and reduces take-home pay for workers.
ularly European countries, ranging fromn 20 to 50 percent of        .         *. i
gross wages (Box Figure 2). But they are also hh  int some   _   _      _      _     _      _      _      _
developing countries, notably in Latin America, where they
are as high as 40 percent4of gross wages. Such taxes reduce the
net wage that firms pay to workers by the fill amount of the:
tax less the value employees attach to the benefits provided.  B     Figur 2 Payroll ta   s a p    n      of
n;  1g  :   : 1   1 17 r         F      D~..  Box Figure 2.:Pa   11 taxes As a percentage of
Payroll taxes are generally earmarked to finance programs
that benefit workers. The most common use of payroll taxes  gross wages
is thef fhunding of pensions, followed by health care programs        o   .1o    20    30o   40    SO   eo
(generally limited to workers or targeted to the poor, but in
some cases extended to the entire population). Third in         ca
importance is the funding of workers compensation for work-
related accidents. In some countries payroll taxes also fund    ..  ..l.m              ...
unemployment insurance pograms. In a number of countries        ispan           _
in Latin Amerca and the Caribbean payroll taxes fund train-  New Zealand
ing institutes.                                                    n
Payroll taxes are often justified on the grounds that work-  United States
ers would not otherwise save for retirement or health insur-   Arpntna
ance and that employers would not insure againstfthe risk of
work accidents or provide training programs. These man-        Coio       
dates typically have three components. a forced savings          Mee
component, ian insurance premnium component and a distri-
butional component.                                            Venenla
The most enforceablesystemscombine insurance policies            F l
with mandatorysavingsprograms toprovide abasicsetof ben-          enya
efits. Overly ambitious programs that requite high contiibu-    Mmocc:
tions are likely to distort the labor market and reduce formal  Snge -
employment. For example, in pay-as-you-go pension systems      Sr tank:a
ing the bargaining process; in this way delays in reaching agree-   organization (including the right to join the union of their choice
ments will be costly to both parties, encouraging a speedy and    or not to join a union). Many countries' regulations also support
efficient resolution of the conflict. In most Latin American cases,   collective  bargaining  in  the private and  public sectors.
however, the costs to employees of striking are low compared    Decentralized bargaining obliges employers to bargain with
with those incurred by employers (Table 9).                  plant-level unions but does not preclude them from bargaining
at a more centralized level, such as with industry-level unions.
Unions                                                         Competitive product markets limit the ability of unions to
Howcanpolicymakerscreateanenvironmenttharminimizesthe    obtain higher wages for their members. Raising wages would
negative effects of trade unions while encouraging them to con-   force unionized firms out of business unless the higher wages
tributetoeconomicgrowthandequity?Experienceindicatesthat   were justified by increased productivity. A survey of twenty
such an environment usually includes competitive product mar-   industrial firms in Brazil found that increased competition in
kets and regulatory and institutional frameworks that are   the output market, the result of trade liberalization, caused those
designed to protect workers' rights to freedom of association and   firms to introduce productivity-enhancing techniques and
20



C U R rr-- N JT   L A S R o F  M AR FK K E T   INTER r_                                                   E -  v r- N T IO r N S
Strikes are generally less costly to Latin American workers than to employers
Table 9. Dispute resolution legislation in ten Latin American countries
Employee rights
To renounce                 Employer rights
To wages             union member-
Judicial                                     while                 ship and return      To lock out       To temporarily       Maximum duration
Country   procedure           To strike                  on strike            to work               employees        replace workers   of a strike
Argentina   Civil courts      Must be called by union    No, if workers fail  No                    No, unless the    No                  No maximum
after conciliation channels  to accept arbitration.                   strike is illegal.
are exhausted. Ministry of   Yes, if the employer
Labor determines legality.   locks out workers.
Bolivia    Labor courts       After arbitration has      No. Strike           Yes                   Yes              No                   No maximum.
failed (requires 24        suspends labor                                                                   Despite the law. many
days after presentation    contracts.                                                                       strikes start before
of petition to labor                                                                                        the Tribunal decision.
inspector). A majority of
the union or two-thirds of
workers must agree.
Brazil     Labor courts      In the context of           No                   Yes. Strke does       Requires prior    No. unless the      No maximum
collective bargaining.                          not suspend labor     authorization.    strike is declared
Quorum requirement                              contracts.                             "abusive' by
decided by head-count                                                                  the labor court.
vote of union members.
Chile      Labor courts have  In the context of          No                   Yes                   Yes, if the strike  Yes, from the first    The strike ends if
jurisdiction over    collective bargaining.                                              affects more than day of the strike if    more than half of the
questions                                                                               half of workers   the last offer is    workers have returned
of application                                                                          or interrupts     equivalent to the   to work.
of the law.                                                                             essential work.   previous contract
adjusted for
consumer price index.
Only after 15 days
otherwise.
Colombia   Labor courts.      After direct negotiations.  No. Strike          No                                     No, unless there is   60 days
Ministry of Labor   Must be agreed by        suspends labor                                               a risk of serious
may call for      absolute majority of       contracts.                                                   damage to the
arbitration within    workers in a secret                                                                facilities.
two days of a     ballot.
declared strike.
Ecuador    Labor Inspectorate  After direct negotiations.    Yes              No                    No               No                   The strike ends when
Must be agreed by                                                                                           the tribunal has
absolute majority of                                                                                       resolved it
workers. 'Solidarity'
strikes permitted.
Mexico     Labor courts       Tripartite board           No, unless the board  No                   No                                    No maximum
must declare it legal.     decides the strike
is 'imputable' to
the employer.
Nicaragua  Civil courts      If agreed by head count     Yes                  Workers can go        Yes. after       No                   No maximum
majority. Does not have                         back to work. but    conciliation
to occur in the context                         wages are paid       if authorized
of collective bargaining.                       in any case.          by Labor
Inspectorate.
Peru       Ministry of Labor   If the majority           No. Strike           Yes                   No               Yes                  No maximum
approves. Few limitations.   suspends labor
contracts.
Venezuela  Labor Inspectorate  After direct negotiations.    No. Strike       No                    Yes              Yes                  No maximum
Must be agreed by          suspends
absolute majority of      labor contracts.
workers. "Solidarity'
strikes permitted.
Source: Dertouzos and Karoly 1992; Cox Edwards 1993.
21



L A r 3 0OR  AN 1 D              r   co N D3 M I C  R a F O R M S
processes. Labor, keen to ensure continued competitiveness, did   lation requires that workers be paid even when they are on
not insist on past privileges but cooperated with management   strike-a clear disincentive to compromise. Moreover, many
in this process.                                            governments refrain from providing loans or deferring tax
In less competitive environments unions attempt to capture   payments for firms during strikes or lockouts, and firms are
economic rents and ally themselves with employers and politi-   not allowed to hire temporary workers. Negotiations between
cians who help to perpetuate those rents. This kind of behavior   unions and public enterprises show how unions are able to
by unions is evident in industrial countries, where union wage   achieve distorted outcomes when third parties bear the cost
premiums are highest in regulated sectors and concentrated   of negotiated agreements. When a public enterprise can turn
industries. In developing economies union opposition to trade   to the government for subsidies or easy credit when it is in
liberalization and privatization is a rational strategy for main-   financial difficulty, the burden of high settlements falls on
taining higher wages for unionized workers in the short run at   those who pay higher prices or higher taxes to cover the enter-
the expense of nonunion workers. If the state imposes regulations   prise's increased costs, not on the workers or enterprise man-
on minimum wages and restrictions on hiring and firing, the   agers who negotiated the increase.
nonunion sector will operate much less effectively as a constraint  Legislating limits on the number of unions per enterprise is
on unions' wage demands. Promoting domestic competition and   viewed as an infringement of workers' rights. When workers
openness to international markets will therefore help to curtail   have the right to choose their own union, unions act as a gen-
these negative effects.                                     uine representative of the worker in collective negotiations.
Furthermore, if the union is contestable (that is, if a new union
Labor regulations and the system of industrial relations    can be set up at any time), unions will be compelled to bargain
Union behavior is conditioned by the structure of union orga-   with employers to improve working conditions. Union frag-
nization and the coverage of collective agreements. A key    mentation and rivalry can be disruptive, however, and bargain-
principle in industrial relations is to ensure that the parties   ing costs rise if workers have many representatives. These issues
engaged in bargaining absorb the costs of their actions rather   are often dealt with through cooperation between unions and
than shift them to third parties. But in some countries legis-   employers.
22



CHAPTER 5
The Changing Role
of the State
L      atin American and Caribbean countries have not yet    Successful reform requires finding ways to isolate agencies
addressed the problem of poorly performing bureau-   from political forces. Their mandate has to be clear and their per-
cracies. Efforts at decentralization often have devolved   formance measurable. Naim (1995) observes that many coun-
responsibilities without granting the authority to raise revenue or   tries have been successful in isolating key public agencies from
control hiring and wages. The problem of public services and   political maneuvering, making them an island of efficient man-
employee performance goes beyond organizational changes,   agement and attention to results. These include national oil com-
downsizing, and better reward systems. Government agencies   panies such as Petroleos de Venezuela, Colombia's National
must learn to see a direct connection between their revenues and   Coffee Company, Chile's state-owned copper company, and
their responsibilities.                                   some Central American agencies that oversee banana exports.
There are many ways to achieve this goal. All combine some  Much can be accomplished by granting more autonomy to
level of greater autonomy for agencies with clearly defined tasks,   public agencies. But this approach cannot be generalized to the
centrally established budgetary allocations, and a defined policy   entire public sector. The previous section discussed the person-
on raising additional revenue. More autonomy would allow    nel management restrictions that are embodied in collective con-
agencies (or local governments) to pursue the most efficient ways   tracts throughout the region. In addition to these, there are often
of providing public goods and services. This will mimic the oper-  special labor statutes for workers in the social sectors (education,
ation of private institutions, where goods and services are pur-   health, and so on). As the experience of the 1980s showed, even
chased or contracted out unless there is a comparative advantage   the most protective legislation cannot shelter workers from reces-
to producing them in-house. In addition, measurable goals and   sions or budgetary cuts. The experience also showed workers that
incentives that reward workers and management are precondi-  they may be better off in a system that rewards them for being
tions for good public sector performance.                 productive. In short, achieving more effective delivery of public
services requires a pragmatic approach that recognizes the impor-
Public sector employment and wages                        tance of local management, understands the incentives each
In delivering public services central governments have no choice   agency faces, and finds ways to correct incentives so that social
but to rely on the administrative capacity of local managers. These   objectives are consistent with those of the local agency. New
managers need to be given autonomy in hiring, promoting, train-   Zealand's recent experience with reforms in public sector man-
ing, and firing employees. But in most cases they are not. More   agement offers an interesting benchmark with which to compare
often, job positions are predetermined, salaries are paid directly   practices in other countries.
by the central government, and promotion criteria are established
by statute. This makes personnel management decisions some-   Setting priorities and choosing better policy instruments
what irrelevant to local operations. Breaking these molds requires   Social expenditures are always limited by budgetary constraints.
more than legal changes to the statutes governing individual agen-   Moreover, the most important consideration for any social
cies. It also requires significant political will, because public sec-   expenditure is how efficiently funds are allocated, measured by
tor unions have the power to paralyze entire administrations.  results in relation to starting goals. Latin American countries
The principal problem posed by public sector unionism is   maintain elaborate bureaucratic structures and complex legisla-
that disputes tend to be costly because the markets involved are  tion that govern the delivery of social services. These countries
generally monopolistic. For this reason, it is natural to seek alter-  should initiate efforts to rationalize their social service institu-
natives to strikes and lockouts. Arbitration by third parties is the   tions. Governments should limit themselves to policy design,
obvious alternative, and the mechanism recommended is "final   control, evaluation, supervision, and financing, leaving execu-
offer" arbitration, which compels the arbitrator to choose either  tion of the programs to decentralized agencies such as munici-
management's final offer or the union's.                  palities, local governments, and private organizations.
23



L A B o R AN  D  E C ON N 0 M I C  RE  F OR  M S
In terms of financing, subsidies that respond to demand have   period of import-substitution industrialization, and most con-
several advantages over indirect, supply-side subsidies. Demand   tinue to provide the same training they always have.
subsidies are easier to target to the neediest groups and are more  But countries have made drastic changes in their economic
likely to attract cofinancing. This principle applies to all areas   policies, there have been significant changes in technology, and
where the public sector has been heavily involved in the financ-   demand for trained personnel has become less predictable.
ing and production of services. Two cases that are of particular   Training institutions must adapt to be effective. Some have
importance for this report are education and worker training.  started to change. In some cases pressures from legal reforms have
deprived them of traditional sources of funding (Bolivia,
Funding education                                            Colombia, and Costa Rica); in others, pressures came from
Higher education has traditionally been subsidized on the sup-   greater exposure to competition for public funding (Chile).
ply side in Latin America. This choice benefits those who qual-   Entrepreneurs have been asked to participate more closely in pro-
ify for a university education, irrespective of their capacity to   gram development, as in Brazil, or to take over the management
pay. That reduces the resources available to the poorest segments   of the system, as in Peru (de Moura Castro 1994).
of society. There is little doubt that education has to improve in  Labor requirements are changing rapidly, yet most institutes
order to continue the export-oriented drive of the last few years.   continue to offer traditional training in electricity or mechanics.
Changing the way that public funding for higher education is   Most of the system's students over the past decade have become
allocated would help expand coverage. Most university gradu-   independent contractors or joined the informal sector. Thus the
ates acquire an earning capacity that would enable them to pay   system's funding has become a tax on modern sector labor and a
for their education. Extending access to public funding to new    transfer to the informal sector. Chile eliminated this earmarked
institutions would give the state more for its money as old and   tax and uses broadly based income taxes to subsidize training. In
new institutions compete for funding. Establishing scholarship   the formal sectors firms receive a tax credit of up to 1 percent of
and loan systems would improve access to university training    payroll if they spend that amount on worker training. This train-
while permitting cost recovery. Chile adopted this principle to   ing can be organized on the job or through public and private
change the formula for grant funding to universities. There has   training institutions.
since been significant growth in the higher education system's  Some traditional training institutes are transforming them-
coverage.                                                    selves into centers of technology transfer. Several schools have
assumed this function and offer a range of courses for private
Worker training                                             entrepreneurs. Traditional training courses remain as part of the
Public training institutions in Latin America and the Caribbean,   broader curriculum. This trend is not only an important way of
with the exception of Argentina and Mexico, are based on the   spreading technological innovations; it is also a useful tool for
Brazilian SENAls model of an autonomous public agency   training institutes to anticipate enterprise needs. These addi-
financed by payroll contributions of I to 2 percent and man-   tional activities have expanded the sources of funding for these
aged jointly by government, workers, and employer representa-   institutes, increasing their autonomy and creating clear links
tives. These institutions played an important role during the   between revenues and responsibilities.
24



CHAPTER 6
The Outlook for Workers
M          any Latin American countries have initiated reforms   ios are illustrative only-the projections are based on many
that will produce important gains for workers in the   assumptions and certainly are not a forecast. But they are a
years to come. Among the more advanced reform-   plausible guide to the consequences of success and failure, and
ers, some (Chile, Colombia) are showing signs of sustained   they take into account likely trends in both economywide
progress for workers.                                     effects and international integration.
Opening the formal labor market requires:                 The divergence scenario assumes that recent investment
* Replacing job security legislation with a system that protects  trends will continue or that investment will deteriorate, that a
workers as they change jobs. This does not necessarily require   sizable share of those enrolled in schools will drop out prema-
establishing new unemployment insurance programs; it can be   turely, and that the overall productivity of labor will not rise
accomplished by improving the system of severance payments   rapidly. The convergence scenario assumes that investment
in countries that lack the administrative capacity to run an   rates will pick up, that enrollment rates will stabilize at current
unemployment insurance scheme.                          levels and dropout rates will decline, and that investments in
* Recontracting social security, lowering payroll taxes, and   infrastructure, technological transfers, and improvements in
making pensions a function of individual savings. This does   the quality of governance will contribute to labor productivity.
not mean that the state should break promises made to those   The convergence scenario must be supported by higher savings
who have contributed to the system or to those who depend   rates, lower fiscal deficits in the industrial countries, and rea-
on pensions. And reform is not inconsistent with the estab-   sonable amounts of international capital flows, including devel-
lishment of transfer programs for the elderly poor. But   opment assistance.
reform can encourage employees to save for their retirement.  In the divergence scenario we assume that protectionism
The initial conditions in each country will determine the   will not go away, and that countries will either drag their feet
level of entitlements that will remain as a liability of the pub-   in implementing the Uruguay Round agreement or offset gains
lic sector.                                             in one area with protectionism of another sort. Here, export
* Establishing freedom to choose labor representation and dis-   growth will be slow and there will be little change in the inter-
pute resolution mechanisms that enhance negotiations at the   national division of labor. In the convergence scenario the
plant level.                                            Uruguay Round is fully implemented and there is further
* Transferring education and training subsidies to the demand   progress in trade liberalization-including in agriculture-at
side. This change will create training institutes that are better   regional and multilateral levels. Global integration will interact
able to respond to rapidly changing labor requirements, par-   with domestic investment in capital and people to bring large
ticularly in countries that are integrating with the world econ-   net gains. Latin America will capitalize on its improved skills
omy. Many countries concentrate their investment in training   mix in the expanding global market, will recover its strength in
on secondary school graduates, so public support to training is   mining and agriculture, and will move into the production of
generally not pro-poor. Subsidies based on demand not only   more technologically demanding goods (Table 10).
can accommodate on-the-job training, they also can be tar-  Both scenarios assume that the technological bias favoring
geted to specific groups.                               skilled workers will continue. Under the divergence scenario
Two global scenarios, developed for World Development  this bias reinforces slow accumulation and stagnating world
Report 1995, illustrate what is possible and the dangers ahead   trade and results in slow GDP growth in most regions and ris-
for each of the world's main regions. The first scenario, based   ing inequality among and within regions, including in Latin
largely on past trends, projects current policies over the long   America and the Caribbean. By contrast, the convergence sce-
term. This scenario, which suggests a widening of differences   nario finds incomes rising and inequality falling. Rapid accu-
between some regions and a widening of inequality within    mulation of skills reduces the pool of unskilled workers and so
some countries, is one of slow growth and divergence. A sec-  increases the demand for their services. Furthermore, rural
ond scenario of inclusion and convergence explores the poten-   areas gain from external conditions and demand for unskilled
tial of strong domestic policy action in all parts of the world   labor in agriculture and services rises. These factors all con-
combined with deeper international integration. Both scenar-  tribute to a reduction in inequalitv.
25



L A, E3 o R    Al N I'     E- c  o  " o  M   I c   R Er F O  r M S
The success of these efforts will depend on both domes-   sector. Better understanding of the link between govern-
tic policies and international conditions. Labor policy has   ment policy and private sector development will improve
generally been overlooked, and this is a mistake. The capac-   the chances for sustained recovery in the region and for a
ity of an economy to modernize, turn toward exports, adapt   more effective war against poverty. Labor markets must be
new technologies, improve service delivery, and so on rests  liberalized in order to expand employment opportunities in
on a better use of resources and a more efficient productive   all sectors.
Table 10. The outlook for Latin America and the Caribbean, 1994-2010
(percent, except where otherwise specified)
Variable                                  Actual            Divergence scenario        Convergence scenario
Inputs in the growth process
Investment share in GDP                (1992) 20.0               22.0                         25.0
Average years of schooling             (1992)  4.9                 5.6                          6.1
Annual growth in TFP                (1960-87)  0.0                 0.6                          1.6
Annual growth
GDP per capita growth               (1970-90)  1.7                 1.4                          3.3
Export growth                       (1980-90)  2.4                 3.8                          7.0
Total increase in wages
Unskilled wages                                                  -3.0                         58.0
Skilled wages                                                    45.0                         62.0
Source: World Bank 1995; Lewis, Robinson, and Wang 1995.
26



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