# **I Introduction**

This paper synthesizes much of the research on Latin American and Caribbean (LAC) labor markets in recent years. Though covering many disparate topics, it does not attempt to be comprehensive, but rather stresses themes that have emerged as central in the work of the region. Several themes emerge particularly relevant to on-going policy dialogues:

**1. Labor legislation matters, but markets may be less segmented than previously thought.** The expanding literature in LAC on non-wage costs, firing restrictions, and nominal wage rigidities suggests that labor regulations do affect most labor outcomes.  The magnitude of these effects is still in dispute.  What does seem clear is that while wage rigidities have been instrumental in generating high unemployment during crises, the emerging view that an important part of informality may be “voluntary,” suggests that the traditional focus on segmentation in the Harris-Todaro tradition may be overstated in normal periods.

**However, there are substantial inefficiencies and distortions in the labor codes that give incentives to both workers and firms to avoid formal institutions** . The value of benefitstraining, pensions, unemployment compensation- is often greatly misaligned with productivity levels and what workers or firms pay either explicitly or implicitly. _This impetus to voluntary informality implies that the design of social safety nets and labor legislation needs to take a more integrated view of the labor market taking into account the cost-benefit analysis workers and firms make about whether to interact with formal institutions._ This analysis incorporates the benefits of such interactions, the availability of informal substitutes, and the weighing of any greater risk exposure against the benefits of being independent and entrepreneurial.

# **2. The impact of labor market institutions on productivity growth has probably been**

**underemphasized.** Draconian firing restrictions increase litigation and uncertainty surrounding worker separations, reduce turnover and job creation, and poorly protect workers.  But theory and anecdotal evidence also suggest that they, and other related state or union induced rigidities, may have an even greater disincentive effect on technological adoption which accounts for half of economic growth.  In this sense, the labor market must be viewed as an key part of the National Innovation System.  These issues take on a heightened importance in the context of more open economies. While there appear to be few long run adverse impacts of trade liberalization, reaping the benefits of greater integration will require greater attention the interactions between trade and labor regulation.

# **3. Institutions can affect poverty and equity, although the effects seem generally small and**

**channels are not always clear.** The majority of earnings differentials are generated by human capital endowments, not labor market institutions, and labor reforms have had indeterminate effects. Some regulations, such as minimum wages, clearly compress the earnings distribution, but if set too high can have opposite effects on _household_ income distribution and poverty. There remain poorly understood differences in conditional earnings and patterns of employment along the lines of race, ethnicity and gender **(** although the evidence for discrimination based segmentation is weak) and related to unmeasured characteristics (early human capital, labor market connections).  In particular, the observed female differentials and concentration in informal self employment seem driven by preferences related to household responsibilities, although in some cases labor provisions discourage women’s regulated hiring.

Overall, the present constellation of labor regulations serves workers and firms poorly and both could benefit from substantial reform.

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