Developing Countries Indicate That Flexible Labour Markets Are Not The Solution To Unemployment

Labour markets in rich and poor countries look remarkably similar in terms of their flexibility. But poorer countries frequently experience considerably lower levels of unemployment, suggesting that the importance of labour market flexibility for low unemployment is exaggerated. That is the implication of a paper by Francis Teal published in the latest issue of the Economic Journal. Drawing on his comparative examination of the wages and employment of manufacturing workers in Ghana, it can be concluded that unemployment in the developed world is high for reasons other than inflexible labour markets.

What causes unemployment is probably one of the most important questions that economists try and answer. One common way of seeking answers to that question is to compare countries, usually across the OECD, where members are similar in terms of industry structure and income. For example, it is often argued that European unemployment is higher than in the United States because the labour market in Europe is less flexible.

The policy implications of this argument are both clear and contentious: anything that creates a less flexible labour market, be it the social chapter of the Maastricht treaty or the welfare state, has a cost – unemployment is higher. In that context, one measure of flexibility is whether workers who have jobs can push up their wages if firms are more profitable: with a flexible labour market, more profitable firms should simply employ more labour.

Teal adopts a different approach to this issue: the comparison implicit in his paper is between rich countries and poor ones. He focuses primarily on Ghana, where average wages for production workers in manufacturing are £30 a month. Such workers are well off relative to many of their compatriots. What”s more, there is no welfare state in Ghana, and measured unemployment is low and has remained so for twenty years. Is the secret of this success a flexible competitive, well functioning, labour market? Teal”s evidence suggests not. In the past, relatively little evidence for developing countries has been available. But now we have data that enables very direct comparison between labour markets in poor and rich countries and the labour markets look remarkably similar.

In particular, more profitable firms seem to pay their workers more rather than hiring more labour. There is no evidence that the labour market in Ghana, where unemployment is low, is more flexible than in the UK, where unemployment is much higher. The implication for policy is that it is easy to exaggerate the importance of labour market flexibility for low unemployment. Unemployment is high for reasons other than inflexible labour markets.

”The Size and Sources of Economic Rents in a Developing Country Manufacturing Labour Market” by Francis Teal is published in the July 1996 issue of the Economic Journal. Teal is a member of the Economic and Social Research Council-funded Centre for the Study of African Economies, University of Oxford and a Fellow of St John”s College, Oxford.

Francis Teal

01865-271077 | francis.teal@economics.oxford.ac.uk