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# **1. Introduction**

This paper reviews the evidence on the impacts of selected labor market institutions. It sets out to make three contributions to the existing literature. First, it includes research findings from studies of countries at all levels of development but a particular effort is paid to developing countries where we know less. Second, an effort is made to go beyond the standard labor market outcome variables and understand how labor market institutions affect a broader set of variables. Third, the review attempts to bridge the two segmented literatures—one based on competitive labor market models and the other on the role of institutions—that have dominated this field of enquiry The laws, practices, policies, and conventions that fall under the umbrella of “labor market institutions” determine _inter alia_ what kinds of employment contracts are permissible; set boundaries for wages and benefits, hours, and working conditions; define the rules for collective representation and bargaining; proscribe certain employment practices; and provide for social protection for workers. The rationale for these institutions can be attributed to four factors: imperfect information, uneven market power (between employers and workers), discrimination, and inadequacies of the market to provide insurance for employment-related risks. Societies almost always introduce labor market institutions to protect workers or to redistribute income to them. However, there may be efficiency considerations as well since institutions can affect the functioning of the labor market and the productivity of firms.

The history of formal labor market institutions originates in the second half of the 19<sup>th</sup> century with the industrialization of Western Europe and North America. During the 1930s and the first three decades after World War II, a “modern” institutional framework was completed in developed countries, with comprehensive labor codes, rules for trade unions and collective bargaining, unemployment insurance, active labor market programs, and equity legislation. Developing countries also introduced similar institutions, often patterned after their colonizers’ laws and traditions (Botero _et al._ 2004). By the 1980s, debates over labor market institutions began to heat up as employment performance started to diverge across developed countries. In particular, the strong record of job creation and low unemployment in the United States relative to much of Europe raised questions about whether Europe’s more stringent labor regulations, more powerful unions and more extensive collective bargaining, and more generous unemployment insurance regimes might be a contributing factor.

Controversies over the role and impacts of labor market institutions have continued over the past two decades. In fact, this debate has intensified as globalization and technological change have exposed developed and developing countries to greater competition and raised the stakes for finding the optimal institutional framework (Hayter 2011). Through this period, the body of empirical evidence on the impacts of labor market institutions has continued to grow. Research in the 1990s, largely based on cross-country regressions, typically found that strong protective legislation and generous unemployment insurance did slow job growth and increase unemployment. These conclusions motivated the influential OECD (1994) Jobs Study which took a largely deregulation stance, recommending flexible rules for protecting employment and setting wages and hours, and unemployment and welfare systems that minimized work disincentives. A parallel body of evidence did not yet exist for developing countries but the dominant policy message was similar: while institutions were introduced with good intentions