Designing Labor Policies to Foster Inclusive Growth in Emerging Markets

IMF Blog, May 21, 2019

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Emerging market economies have enjoyed good growth in recent decades but are still far from closing gaps in living standards with advanced economies.
Emerging markets need growth to be shared by everyone, particularly by providing their growing populations with good jobs and social protection.
A new IMF staff paper examines how the design of labor markets—institutions and policies—could foster inclusive growth in these countries.

Only half of emerging markets have unemployment insurance systems in place, while they exist in nearly all advanced economies.
Employment protection legislation is just as prevalent in emerging markets as in advanced economies; emerging markets out-rank advanced economies—at least in law—on severance pay.
Collective bargaining agreements cover only about 20 percent of workers in emerging markets and about half of workers in advanced economies.
The ratio of the minimum wage to the median wage is higher in emerging markets than in advanced economies (the minimum wage is closer to the median wage, partly reflecting low median wages).

Creating high-paying jobs requires replacing unproductive jobs with more productive ones; workers need basic protections during reallocation.
Unemployment insurance provides income support while workers search for new jobs; employment protection legislation (e.g., valid grounds for dismissal, severance pay) protects jobs by limiting firing or reallocation.
Evidence from advanced economies suggests protecting workers more through unemployment insurance than through very stringent employment protection legislation.
The Nordic model (moderate and predictable employment protection combined with high unemployment benefits and active labor market policies) is highlighted as an example.
In emerging markets:
- The need to provide insurance against income loss is greater than in advanced economies.
- The risk that policies fail is greater owing to widespread labor market informality and limited administrative capacity.
- Greater reliance on employment protection legislation can produce a dual labor market of protected formal sector workers and a large unprotected informal sector, and can be an obstacle to creating formal-sector jobs.
Policy recommendation:
- As informality is reduced and administrative capacity improves, there is a case to gradually expand unemployment insurance and move toward less stringent and more predictable employment protection legislation.

Over the past decade, IMF advice to 30 emerging and frontier market economies has generally advocated expanding unemployment insurance and reducing severance payments.
Examples:
- Chile, Malaysia, and Turkey were advised to introduce or expand unemployment insurance systems while lowering severance payments.
- Morocco and Indonesia were advised to lower very high legal severance payments, which can channel work to the informal sector and foster labor market segmentation.

Minimum wages serve an important distributional purpose in emerging markets by providing a basic standard of living and reducing employer underpayment.
If set too high relative to median wages, minimum wages can dissuade companies from hiring low-skilled workers, limiting skill accumulation.
Policy guidance:
- Balance distributional needs against possible adverse impacts on job creation.
- One route: set minimum wages to a reasonable level (relative to the median wage) and complement them with programs such as cash transfer programs or—in places with sufficient administrative capacity—in-work tax credits.
- Examples of successful targeted income-support programs: Dibao in China and Bolsa Familia in Brazil.
- Another route: have lower minimum wages for certain groups of workers or in certain regions where they are particularly high relative to the local median wage.
IMF country-specific advice examples:
- Philippines and South Africa: advocated setting the national minimum wage so as not to hurt job creation while recognizing goals of reducing inequality and providing minimum household income needs; recommended using social transfers and progressive taxation to meet distributional goals.
- Malaysia: advice included lowering minimum wages in some regions.

Collective bargaining can complement legally required minimum wages in setting decent wages and working conditions.
Sector-wide bargaining is difficult to implement; success in advanced countries (e.g., Germany, the Netherlands) depends on:
- Whether interests of all individual companies are well represented at the bargaining table.
- Whether worker representatives coordinate among themselves.
- Whether sector-level agreements provide minimum flexibility to accommodate different firms’ needs.

IMF labor market advice has evolved to emphasize social protection and more inclusive growth, while still assessing how institutions can support economic efficiency.
IMF advice is broadly consistent with academic literature on fostering flexibility while strengthening safety nets.
Important next steps identified:
- Better integrate efficiency and equity considerations.
- Provide more specific advice in each area.
- Account for interactions across different policy areas.

IMF blog — Romain Duval, Prakash Loungani; May 21, 2019.