quality of human capital has been a critical ingredient in the East Asian Miracles’ success in the world market.

- **<u>Are labor market rigidities preventing more adjustment?</u>** As noted above, what the IADB found surprising was the low level of intersectoral allocation of workers and, overall, the literature has found modest changes in rates of turnover. Again, a much broader agenda is required on the impact of regulation on technological adoption, that would, in all probability, increase both flows, and the ability of small firms to exploit economies of scale.

# **III. Protecting Workers**

The issue of the optimal design of worker protections is complicated and the region has made some small progress on the issue in recent years. This section discusses the importance of the phenomenon of informality, the deficiencies of extant employment protections, the impact of nonwage costs, the employment and poverty implications of minimum wages, and the impact of unions. Heckman and Pages (2004) have summarized much of the recently emerging literature and only select references will be mentioned here. A theme throughout this section is that the study labor legislation needs to move away from a traditional focus on segmentation and job creation in a static sense, toward a focus on the labor market as an integral part of the National Innovation System, the constellation of institutions and firms that are involved in dynamic productivity gains through technological progress. (See De Ferranti et al 2003).

# **a. Informality**<sup>**5**</sup>

The informal sector merits treatment first not only because it is ostensibly the largest mass of unprotected workers, but also because recent evolution in thinking has implications for the design of social protection systems.

**_The informal sector comprises both workers preferring formal sector employment (involuntarily informal) and those preferring the qualities of unregulated entrepreneurship._** In motivation surveys from Brazil and surveys of workers leaving formal employment in Mexico, 60-70% report preferring informal self employment for reasons of independence and higher earnings.<sup>6</sup> Though difficult to measure job characteristics make wage comparisons _faux amis_ for establishing segmentation, numerous studies have established higher earnings among informal workers, particularly the urban self employed.<sup>7</sup> Recent studies for Brazil and Bolivia that attempt to control for selectivity into the sector find that predominantly informal salaried workers at the bottom of the salary scale within any skills set face a significant wage disadvantage vis-á-vis formal jobs.<sup>8</sup> Attempts to compare welfare more directly find a premium to being informally self employed in Bolivia (Arias and Sosa 2004), consistent with the sociological evidence from Mexico finding self employment is often considered a step up from salaried work.  As discussed below, women appear to

> 5  See background papers by Maloney and Saavedra

> 6, Cunningham and Maloney (2002), Maloney (2004)

> 7 See Yamada (1996), Marcouiller, Ruiz and Castilla and Woodruff (1997), Maloney (1999), Saavedra and Chong (1999), Gong and van Soest (2002).

> 8 Tannuri and Pianto (2003) and Tannuri, Pianto and Arias (2004).

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