Creating

26 DOING BUSINESS IN 2006
Why reform?
The International Labour Organization has established a
set of fundamental principles and rights at work, including
the freedom of association, the right to collective
bargaining, the elimination of forced labor, the abolition
of child labor and the elimination of discrimination in
hiring and work practices. 6 Beyond adopting and enforcing
these regulations, governments struggle to strike
the right balance between labor market flexibility and
job stability. Most developing countries err on the side
of excessive rigidity, to the detriment of businesses and
workers alike.
Flexible employment regulation increases productivity.
Analysis suggests that if Paraguay adopted the employment
regulations of Chile—moving from the 20th
to the 80th percentile on the rigidity of employment
index—it might increase its annual productivity growth
by up to 1 percentage point. That would represent a
doubling of the rate. 7
But if employment regulation is rigid, businesses
seek other means of staying competitive. They hire
informal workers, pay them under the table and avoid
providing social benefits, as Doing Business in 2005
reported. And when parents fail to find decent employment,
children often end up working too.
Reforms of employment regulation reduce business
costs by increasing firms’ ability to adjust to new technologies,
macroeconomic shocks and inflows of immigrant
labor. 8 The result is a higher employment rate. In
OECD countries with flexible laws, it is 2–2.5 percentage
points higher. 9
Flexible employment regulation also increases the
benefits of trade liberalization. 10 As the economy opens,
competition from now-cheaper imports drives jobs
away from less productive sectors and into more productive
ones, expanding the economy. But this happens
only if workers can move. Where barriers to hiring and
firing are high, labor stays in unproductive sectors. The
result is less job creation and a loss of competitiveness, as
in much of Latin America in the past decade. These are
not the kinds of effects legislators had in mind.
Notes
1. In particular, there is no correlation between social security
taxes and the rigidity of employment index.
2. World Bank (2005b).
3. Meadows (2003).
4. European Council (1997).
5. A number of countries have conducted studies on the effectiveness
of such reform in attracting young employees and
providing them on-the-job training. All have found positive
results. See, for example, Neumark and Wascher (2004).
6. ILO (various years). Economic studies show that the presence
of such fundamental rights improves productivity.
7. Caballero and others (2005).
8. Angrist and Kugler (2003).
9. Blanchard and Philippon (2004) and Pierre and Scarpetta
(forthcoming).
10. Bolaky and Freund (2004).