Labor Market Dynamics, Informality and Regulations in Latin America

IMF Working Papers, January 31, 2020

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Labor markets in Latin America and the Caribbean (LAC) are characterized by high levels of informality and relatively rigid regulation.
The paper shows that informality and rigid regulation are related and together slow the speed of adjustment of employment to shocks, especially when regulations are tightly enforced.
Evidence suggests that strict labor market regulations have an adverse effect on medium-term growth.
Regulations on prices (minimum wages) and quantities (employment protection) both decrease the speed of adjustment to shocks but bind in different phases of the cycle:
- Minimum wages affect mostly the (net) job creation margin.
- Employment protection affects mostly the (net) job destruction margin.
Results highlight possible interactions between labor market regulations and the effectiveness of macro-stabilization tools—including exchange rate depreciation.

High informality and relatively rigid labor market regulation are correlated features in LAC.
Combined presence of informality and strict enforcement slows employment adjustment to shocks.
Strict labor market regulations negatively affect medium-term growth.
Distinct regulatory instruments bind in different parts of the employment cycle:
- Price regulation (minimum wages) → net job creation margin.
- Quantity regulation (employment protection) → net job destruction margin.
Interactions exist between labor market regulations and macro-stabilization effectiveness (explicitly noted: exchange rate depreciation).

Reforms addressing both informality and regulatory rigidity could improve the speed of employment adjustment to shocks.
Differentiated policy responses may be needed because:
- Adjusting minimum wage policies primarily influences job creation margins.
- Modifying employment protection primarily influences job destruction margins.
Consideration of how labor market regulations interact with macro-stabilization tools (for example, exchange rate policy) is important when designing policy mixes.