## 4. Unemployment and Structural Change

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---

### I. Introduction
- Structural shifts in Mauritius over the last two decades:
  - Rapid development of manufacturing in the 1980s (largely through EPZ enterprises).
  - Emergence of financial services and tourism since the early 1990s.
  - Further demand for high-skilled workers expected with government promotion of an information communications technology sector and free port activities.
- Real growth and unemployment patterns:
  - Economic growth averaged just below 6 percent per year over the last two decades.
  - Growth averaged 5½ percent per annum between 1991 and 2002.
  - Unemployment followed a U-curve: plunged from about 21 percent to less than 4 percent from the early 1980s to the early 1990s, then rose steadily to approximately 10 percent by end-2002.
- 2000 census profile of the unemployed:
  - Majority young, had never held a job, had failed primary or secondary school education, had no technical or vocational training, and were single and family supported.
- Observed paradoxes in the 1990s:
  - EPZ experienced labor shortages and imported foreign workers (mainly from China).
  - Number of unfilled skilled-job vacancies, especially in financial services, increased.
- Paper objectives:
  - Present a simple analytical model to explain the unemployment puzzle (the U-curve).
  - Identify central institutional imperfections in the Mauritian labor market and suggest reforms.

### II. Literature Survey and Analytical Framing
- Key conceptual points from the literature:
  - Skill-biased technical change raises relative demand for skilled labor and the skill premium.
  - Caselli (1999) framework: capital-specific skills, heterogeneous learning costs, and adoption-stage wage inequality; over longer horizons skilled supply can rise but a split labor market may persist.
- Limits of prior models:
  - Caselli (1999) abstracts from unemployment and from labor market institutions and education-system constraints.
  - Continental Europe’s experience suggests institutional factors can produce rising structural unemployment rather than only wage inequality.
- Innovation of this paper:
  - Introduces labor market institutions (centralized wage bargaining) into a Caselli-type model.
  - Centralized bargaining can limit the skill premium, producing:
    - Faster wage growth for unskilled workers that destroys jobs in traditional unskilled sectors.
    - Inadequate supply of skilled workers given learning and education costs.
  - Net effect: job losses in traditional sectors may not be offset by job creation in high-skilled sectors, producing a rise in overall unemployment during early structural change.
- Policy implication from framework:
  - Supply-side: educational reforms to increase skilled labor supply.
  - Demand-side: revise wage-setting institutions and laws to address rigidities on the labor demand side.
  - Combined reforms expected to increase labor market flexibility, reduce unemployment, and sustain growth.

### III. Mauritian Labor Market Institutions and Education System
- Wage-determining institutions and features:
  - Tripartite Committee: determines wages at national level via consultations (government, trade unions, private sector); wage agreements are legally binding.
  - National Remuneration Board (NRB): sets minimum wages by worker category for 29 sectors; more than 400 minimum wages exist; changes are not made uniformly (some are a decade old); NRB stipulates conditions of work associated with pay levels.
  - Pay Research Bureau (PRB): recommends public sector salaries.
  - Arbitration tribunals: Permanent Arbitration Tribunal (private sector) and Civil Service Arbitration Tribunal (public sector); awards often take little account of productivity or external competitiveness.
- Effects of centralized wage determination:
  - Discourages sector-specific competitive wage setting; creates strong relationship between wages in traditional sectors and emerging sectors.
  - Wage rises in emerging sectors tend to be followed by wage increases in traditional sectors, weakening link between wages and productivity in traditional sectors.
  - Rising wages in traditional sectors reduce domestic demand for unskilled workers and tend to increase unemployment among unskilled workers.
  - Constrained skill premium reduces incentives for youth to invest in education and supply skilled labor to new sectors.
- EPZ labor segmentation:
  - Legal minimum wages do not apply to foreign contract workers in the EPZ; foreign workers are predominantly contract workers from China.
  - Employers have greater flexibility in discharging foreign workers: no severance allowances required before retrenching foreign workers; advance notification to the Termination of Contract of Services Board not required.
  - Domestic job seekers view EPZ employment as unattractive due to low pay and high insecurity despite somewhat better working conditions for domestic EPZ workers than foreign workers.
- Education system constraints:
  - High literacy but weak secondary and technical education, especially in natural sciences, engineering, and vocational subjects.
  - Access constraint: almost 35 percent of students fail to pass the completion-of-primary-education examination and drop out at age 12 or 13, partly due to inadequate secondary educational facilities.
  - High cost of acquiring secondary education because of limited access.
- Net consequence:
  - Skilled-labor demand in emerging sectors is largely unmet by skilled-labor supply, dampening labor demand growth.
  - Relative equality of wages across sectors plus high cost of secondary education leads to low skilled-labor supply, limiting growth in emerging sectors and economy-wide labor demand.

### IV. Analytical Model (Two-Sector, Overlapping Generations)
- Framework overview and assumptions:
  - Two development stages: Stage 1 — single traditional low-skilled sector (sector 1); Stage 2 — after technological change, a new high-skilled sector (sector 2) emerges.
  - Traditional sector examples: sugar and textiles (sector 1). Emerging sector examples: financial services and high-end tourism (sector 2).
  - Overlapping-generations setup: each generation lives two periods; workers heterogeneous in ability to acquire education; workers endowed with one unit of unskilled labor; choice to acquire higher education at cost c + σ(I) where c is fixed cost and σ(I) is learning cost; σ(i) distributed uniformly on (0, σ).
  - Domestic labor markets in both sectors are perfectly competitive; no labor reallocation frictions assumed in the model but institutional links exist via wage bargaining; capital markets imperfect leading to investment diversion; no capital depreciation.
- Sectoral production and wages:
  - Sector 1 aggregate production: Y1t = K1t^α L1t^(1−α).
  - Domestic wage in sector 1: wd,1t = w1 + f, where w1 is international wage and f is the domestic premium.
  - Foreign labor supply to sector 1 is elastic and paid international wage w1.
  - Sector 2 production after technological injection at time T: Y2t = A K2t^α L2t^(1−α), where A > 1.
  - Institutional link between sector wages: wd,1t = λ w2t, where λ is an exogenous parameter reflecting centralized wage bargaining tying sector 1 wages to sector 2 wages.
- Supply and demand for skilled labor:
  - Skilled-labor demand in sector 2 depends on A, K2t, and w2t (expressed in model as L2t = (A K2t)^α / w2t^(1/(1−α))).
  - Skilled-labor supply to sector 2 determined by wage differential and education cost: workers with educational cost less than wage differential join sector 2; supply depends explicitly on c and σ.
- Mechanisms generating the unemployment U-curve:
  - Centralized wage bargaining limits the skill premium, so increases in sector 2 wages raise sector 1 wages (via λ), reducing domestic employment in sector 1.
  - Foreign workers fill remaining sector 1 demand.
  - With the constrained skill premium, many domestic workers do not find it profitable to pay c + σ to acquire skills, so skilled supply lags.
  - Total unemployment Ut combines sectoral employment gaps and foreign labor inflows; during transition when sector 2 capital deepens but skilled supply lags, unemployment can rise.
  - Model yields an interior K2 (K2*) at which unemployment is maximized, implying a U-shaped unemployment path during structural change.
- Long-run possibilities:
  - Unemployment may decline after several generations as more workers invest in skills and join sector 2.
  - Diminishing returns to capital accumulation may keep unemployment above previous lows.
  - Multiple successive technological revolutions could indefinitely prolong elevated unemployment.

### V. Concluding Remarks and Policy Recommendations
- Diagnosis: two principal causes of rising unemployment in Mauritius:
  - Highly centralized wage determination limits the skill premium, causing job destruction in traditional sectors and insufficient job creation in new technology sectors.
  - Education system shortcomings fail to supply required higher skills, creating a skill mismatch.
- Supply-side reform measures (already under way and recommended to be pursued aggressively):
  - Increase years of compulsory schooling from nine to eleven years by 2005.
  - Improve and increase access to primary and secondary schools.
  - Introduce information communications technology in primary and secondary schools.
  - Review quality and relevance of curricula.
  - Reform the examination system at the primary level.
  - Government has significantly increased capital spending in education to accompany reforms.
- Demand-side / institutional reform recommendations:
  - Recognize that labor market institutions are rigid and complex; while they reflect a long-standing “social contract,” welfare losses under current framework are likely for workers and employers.
  - Proposed two-tier wage determination system:
    - First tier: maintain a national body (government, employers, workers) but limit it to setting indicative nonbinding wage guidelines.
    - Second tier: encourage firm-level collective bargaining so firm- and sector-specific factors, including productivity levels, can be taken into account.
  - Expected outcomes: increased labor market flexibility, reduced unemployment, and sustained high growth levels.

*IMF staff working paper chapter "4. Unemployment and Structural Change" (Mauritius).*

### References..............................................................................................................

### _wp03211 - References......................................................................................................................................17

### Figures

- 1. Real GDP Growth, Employment Growth, and Unemployment Rate, 1982–2002 .................4
- 2. Domestic Employment of Sectors 1 and 2, Foreign Employment of Sector 1,  
         and Total Unemployment, 1982-2002 ..........................................................................10
- 3. Average Wages and Skill Premium of Sectors 1 and 2, 1982-2002 .....................................12

*Source: _wp03211 - References..............................................................................................................*

### 4. Unemployment and Structural Change .................................................................................1

### 4. Unemployment and Structural Change

### I. Introduction
- Mauritian economy experienced profound structural changes during the last two decades: rapid development of manufacturing in the 1980s (largely through EPZ enterprises), and emergence of financial services and tourism since the early 1990s; further demand for high-skilled workers expected with government promotion of an information communications technology sector and free port activities.
- Real growth and unemployment patterns:
  - Economic growth averaged just below 6 percent per year over the last two decades.
  - Growth averaged 5½ percent per annum between 1991 and 2002.
  - Unemployment exhibited a U-curve: plunged from about 21 percent to less than 4 percent from the early 1980s to the early 1990s, then rose steadily to approximately 10 percent by end-2002.
- 2000 census profile of the unemployed: majority young, had never held a job, had failed primary or secondary school education, had no technical or vocational training, and were single and family supported.
- Paradoxes in the 1990s:
  - EPZ experienced labor shortages and imported foreign workers (mainly from China).
  - Number of unfilled skilled-job vacancies, especially in financial services, increased.
- Paper objectives:
  - Outline a simple analytical model to explain the unemployment puzzle, especially the U-curve phenomenon.
  - Identify central institutional imperfections in the Mauritian labor market and suggest reforms.

### II. Literature Survey and Analytical Framing
- Skill-biased technical change literature:
  - Technological revolutions increase relative demand for skilled labor and raise relative wages (skill premium).
  - Caselli (1999) framework: new capital with higher productivity requires capital-specific skills; learning costs are heterogeneous; wage gap emerges; low-learning-cost workers switch to new capital; high-learning-cost workers remain with traditional capital; wage inequality rises during adoption stage.
  - Over longer horizons, increasing supply of skilled workers can reduce wage inequality, but steady-state may retain a split labor market.
- Limits of prior models for explaining unemployment:
  - Caselli (1999) abstracts from unemployment and from labor market institutions and education-system constraints.
  - Continental Europe’s rising structural unemployment (rather than wage inequality) suggests institutional factors matter.
- Innovation of the paper’s framework:
  - Introduces labor market institutions (in particular centralized wage bargaining) into a Caselli-type model.
  - Centralized wage bargaining can limit the skill premium, causing:
    - Faster wage growth for unskilled workers that destroys job opportunities in the traditional unskilled sector.
    - Inadequate supply of skilled workers given learning and education costs.
  - Net effect: job losses in traditional sectors may not be offset by job creation in high-skilled sectors, producing a rise in overall unemployment at least during the early phase of structural change.
- Policy implication from framework:
  - Supply-side: educational reforms to increase skilled labor supply.
  - Demand-side: revise wage-setting institutions and laws to address rigidities on the labor demand side.
  - Combined reforms expected to increase labor market flexibility, reduce unemployment, and sustain growth.

### III. Mauritian Labor Market Institutions and Education System
- Key national wage-determining institutions:
  - Tripartite Committee: determines wages at national level via consultations (government, trade unions, private sector); wage agreements are legally binding.
  - National Remuneration Board (NRB): sets minimum wages by worker category for 29 sectors; more than 400 minimum wages exist; changes are not made uniformly (some are a decade old); NRB stipulates conditions of work associated with pay levels.
  - Pay Research Bureau (PRB): recommends public sector salaries.
  - Arbitration tribunals: Permanent Arbitration Tribunal (private sector) and Civil Service Arbitration Tribunal (public sector); awards often take little account of productivity or external competitiveness.
- Effects of centralized wage determination:
  - Discourages sector-specific competitive wage setting; creates strong relationship between wages in traditional sectors and emerging sectors.
  - Wage rises in emerging sectors tend to be followed by wage increases in traditional sectors, weakening link between wages and productivity in traditional sectors.
  - Rising wages in traditional sectors reduce domestic demand for unskilled workers and tend to increase unemployment among unskilled workers.
  - Constrained skill premium reduces incentives for youth to invest in education and supply skilled labor to new sectors.
- EPZ labor segmentation:
  - Legal minimum wages do not apply to foreign contract workers in the EPZ; foreign workers are predominantly contract workers from China.
  - Employers have greater flexibility in discharging foreign workers: no severance allowances required before retrenching foreign workers; advance notification to the Termination of Contract of Services Board not required.
  - Domestic job seekers view EPZ employment as unattractive due to low pay and high insecurity despite somewhat better working conditions for domestic EPZ workers than foreign workers.
- Education system constraints:
  - High literacy but weak secondary and technical education, especially in natural sciences, engineering, and vocational subjects.
  - Access constraint: almost 35 percent of students fail to pass the completion-of-primary-education examination and drop out at age 12 or 13, partly due to inadequate secondary educational facilities.
  - High cost of acquiring secondary education because of limited access.
- Net consequence:
  - Skilled-labor demand in emerging sectors is largely unmet by skilled-labor supply, dampening labor demand growth.
  - Relative equality of wages across sectors plus high cost of secondary education leads to low skilled-labor supply, limiting growth in emerging sectors and economy-wide labor demand.

### IV. Analytical Model (Two-Sector, Overlapping Generations)
- Framework overview:
  - Two development stages: Stage 1 — single traditional low-skilled sector (sector 1); Stage 2 — after technological change, a new high-skilled sector (sector 2) emerges.
  - Traditional sector in Mauritius: sugar and textiles (sector 1). Emerging sector: financial services and high-end tourism (sector 2). Both new activities considered “high-skilled” relative to the traditional sector.
  - Overlapping-generations setup: each generation lives two periods; workers heterogeneous in ability to acquire education; workers endowed with one unit of unskilled labor; choice to acquire higher education at cost c + σ(I) where c is fixed cost and σ(I) is learning cost; σ(i) distributed uniformly on (0, σ).
  - Domestic labor markets in both sectors are perfectly competitive; no labor reallocation frictions assumed in the model but institutional links exist via wage bargaining; capital markets imperfect leading to investment diversion; no capital depreciation.
- Pre-technological-change (sector 1) setup and implications:
  - Sector 1 aggregate production: Y1t = K1t^α L1t^(1−α).
  - Labor demand and domestic wage: domestic wage set by central bargaining and higher than international wage w1 (foreign wage); domestic wage written as wd,1t = w1 + f.
  - Foreign labor supply in sector 1 is elastic and fills shortages; foreign wages equal international wage w1.
  - Unemployment declines as capital stock in sector 1 increases (1980s experience): domestic and foreign employment in sector 1 rose and unemployment fell.
- Structural change and sector 2 emergence:
  - At time T a large injection of technology capital creates sector 2.
  - Sector 2 production: Y2t = A K2t^α L2t^(1−α), where A > 1.
  - Wage in sector 2 rises with capital-skilled labor ratio; institutional link: wd,1t = λ w2t (equation (9)), where λ is exogenous parameter, reflecting centralized wage bargaining tying sector 1 wages to sector 2 wages.
  - Skilled-labor demand in sector 2: L2t = (A K2t)^α / w2t^(1/(1−α)) (as per model expressions).
  - Skilled-labor supply to sector 2 driven by wage differential and education cost: workers with educational cost less than wage differential join sector 2; expression for skilled supply depends on c and σ.
- Key model mechanisms and results:
  - Centralized wage bargaining limits the skill premium (constrains wage differential), which:
    - Raises wages in sector 1 following sector 2 wage increases, reducing domestic employment in sector 1.
    - Keeps foreign workers filling remaining sector 1 demand.
    - Reduces incentives for investment in skills (because wage differential insufficient to cover c + σ for many workers).
  - Total unemployment U_t is given by expressions combining sectoral employment gaps and foreign labor inflows; unemployment can increase during the transition when sector 2 capital deepens but skilled supply lags.
  - Derivation yields an interior level of K2 (K2*) at which unemployment is maximized; the model implies a U-shaped path for unemployment during structural change.
  - Long-run possibilities:
    - Unemployment might decline after several generations as more workers invest in skills and join sector 2.
    - Diminishing returns to capital accumulation may keep unemployment above previous lows; multiple successive technological revolutions could indefinitely prolong elevated unemployment.

### V. Concluding Remarks and Policy Recommendations
- Diagnosis:
  - Two main causes of rising unemployment in Mauritius:
    - Highly centralized wage determination limits the skill premium, causing job destruction in traditional sectors and insufficient job creation in new technology sectors.
    - Education system shortcomings fail to supply required higher skills, creating skill mismatch.
- Supply-side reform measures (already under way and recommended to be pursued aggressively):
  - Government education reforms aim to:
    - Increase years of compulsory schooling from nine to eleven years by 2005.
    - Improve and increase access to primary and secondary schools.
    - Introduce information communications technology in primary and secondary schools.
    - Review quality and relevance of curricula.
    - Reform the examination system at the primary level.
  - Government has significantly increased capital spending in education to accompany reforms.
- Demand-side / institutional reform recommendations:
  - Labor market institutions are rigid and complex; while reflecting a long-standing “social contract,” welfare losses under current framework are likely for workers and employers.
  - Proposed approach: establish a simplified, two-tier wage determination system:
    - First tier: a national body (government, employers, workers) maintained but limited to setting indicative nonbinding wage guidelines.
    - Second tier: encourage firm-level collective bargaining so firm- and sector-specific factors, including productivity levels, can be taken into account.
  - Expected outcomes: increased labor market flexibility, reduced unemployment, and sustained high growth levels.

*Source: IMF staff working paper chapter "4. Unemployment and Structural Change" (Mauritius).*

### REFERENCES

### _wp03211 - REFERENCES

### References
- Bank of Mauritius, 2002, “Annual Report,” Port Louis, Mauritius.
- Caselli, Francesco,1999, "Technological Revolutions," American Economic Review, Vol. 89 (March), pp.78-102.
- Center for Applied Social Research, 2001, “Attitudes of the Unemployed Towards Accepting Employment in the Export Processing Zone in Mauritius,” Port Louis, Mauritius.
- Coe, David T., and others, 2002, Mauritius—Selected Issues and Statistical Appendix, IMF Staff Country Report No. 02/144 (Washington: International Monetary Fund).
- Dowrick, Steve, and Norman Gemmell, 1991, “Industrialization, Catching Up and Economic Growth: A Comparative Study Across the World’s Capitalist Economies,” Economic Journal, Vol. 101 (March), pp. 263-75.
- International Monetary Fund, 2003, World Economic Outlook, April 2003: Growth and Institutions, World Economic and Financial Surveys (Washington).
- Juhn, Chinhui, Kevin M. Murphy, and Brooks Pierce, 1993, “Wage Inequality and the Rise in Returns to Skill,” Journal of Political Economy, Vol. 101 (June), pp. 410-42.
- Katz, Lawrence, and Kevin M. Murphy, 1992, “Changes in Relative Wages, 1963-1987: Supply and Demand Factors,” Quarterly Journal of Economics, Vol. 107 (February), pp. 35-78.
- Solow, Robert. M., 1956, “A Contribution to the Theory of Economic Growth,” Quarterly Journal of Economics, Vol. 70 (February), pp. 65-94.

*Source: _wp03211 - REFERENCES*

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