VoxEU Column Development Labour Markets

The demand for labour (de)regulation in developing countries: Revisiting the insider-outsider divide

A standard argument in labour economics is that labour regulations benefit the ‘insiders’ who are covered by them, but hurt the ‘outsiders’ who are not. This column provides evidence on outsiders’ preferences for labour regulations in developing countries. Contrary to the predictions of the insider-outsider theory, unemployed and informal workers are found to be in favour of increasing labour regulations across all countries studied.

A standard argument in labour economics is that labour regulations benefit the ‘insiders’ who are covered by them, but hurt the ‘outsiders’. The classic example is the institution of a minimum wage in a competitive labour market, set at a level higher than the market-clearing wage. This reduces total employment, and thus hurts those who are made unemployed (the outsiders) while benefiting those who remain in employment (the insiders).

The presumption that outsiders are hurt by regulations, raises a question on the political economy of how these regulations are in fact maintained. Persson and Tabellini (2002, p. 147) encapsulate what has become a standard view in the analytical and policy discourse:

“Employed and unemployed voters disagree over firing flexibility: the currently employed insiders want to protect their jobs, and thus dislike flexibility, whereas the unemployed outsiders welcome flexibility, as it raises the hiring rate. The unemployed constitute a minority, however, and equilibrium policy is thus chosen so as to please the employed voters.”

What about situations where, as in most developing countries, the ‘covered’ or formal sector is far smaller in numbers than the informal sector? Here, the argument is that insiders are still over-represented in the policy process due to their capacity to collectively organize and to contribute financially in the political domain. Thus, the regulations stay nonetheless.

Hence, the underlying prediction is that outsiders, in general, dislike Employment Protection Legislation (EPL) in its many dimensions, and they would have them removed or reduced if only they had the political power to do so. It is fair to say that this is the general stance of the influential insider-outsider perspective introduced by Lindbeck and Snower (1988). An empirical corollary to verify the basic claim might be to simply ask outsiders about their views on such regulations. Presumably, if they dislike them so much, they would say so. Surprisingly, there is very little such evidence for developed countries, and almost none for developing countries.

The little evidence on developed countries finds mixed results. Rueda (2005, p.65) reports that 64% of insiders compared to 58% of outsiders in 16 OECD countries consider ‘job security’  a very important characteristic of a job. The difference in agreement between insiders and outsiders is hence quite modest, and the majority of outsiders actually prefer job security.  But, testing the insider–outsider divide requires data on workers’ preferences for specific protective labour regulations, such as severance payment, firing restrictions, or minimum wages and not just job security. Guillaud and Marx (2014) analyse support for such policies in an electoral context in France. The authors find that temporary outsider workers do not differ from permanent insider workers, while the unemployed are about 11 percentage points more likely to support the single employment contract (i.e. deregulation) than permanent workers. However, Svalund et al. (2016) study preferences for EPL in Nordic countries and observe that insiders are even more prone to demand deregulation than outsiders.

For developing countries, data on workers’ attitudes to EPL is almost non-existent. Among the very few studies, Baker and Velasco-Guachalla (2018) find that differences in political preferences between formal and informal workers are absent  in Latin America. One reason for the paucity of studies is that there are very few surveys which actually ask workers’ views on labour regulations. In Ronconi et al. (2019), three data sources are explored to provide initial insight into outsider preferences for EPL in developing countries.

In 2008, the Latin American public Opinion Project (LAPOP) included the following question for Argentina, Chile, and Venezuela: “Do you think that an increase in the minimum wage will improve your labour situation?”. Figure 1 shows the share of outsiders, defined as employees without a legally mandated work contract, who report a positive answer. In the three countries, the majority of outsiders support an increase in the minimum wage, from 62% in Argentina to 75% in Venezuela. They do not think that a higher minimum wage would make their labour situation worse, contrary to the prediction of the insider–outsider theory.

Figure 1 Employees without a work contract who support a higher minimum wage, %

Source: Authors’ calculations from LAPOP (2008) data.

In 2006 and in 2016 the International Social Survey Programme (ISSP) asked the following question: “Are you in favour or against reducing the working day to create more jobs?”. The survey covers many developing countries such as Chile, Dominican Republic, Suriname, and Venezuela in Latin America, Georgia, India, Philippines, Thailand, and Turkey in Asia, and South Africa. Figure 2 shows the results for unemployed workers. We have pooled both surveys and grouped workers by continent, but, qualitatively, the same result is observed in every country survey. Again, the majority of outsiders support rather than reject labour regulations.

Figure 2 Unemployed workers who are in favour, against, and neither against nor in favour of reducing the working day, %

Notes: Pooled data from ISSP 2006 and 2016 waves. Source: Authors’ calculations from ISSP (2008, 2018) data.

Given the paucity of information on this important topic, we collected our own data to supplement the standard surveys above. Rather than estimating population parameters, our objective here is to provide cost-efficient suggestive evidence based on questions explicitly designed to collect preferences for reforms of EPL. During 2016, we asked 1,000 individuals to answer a very short survey while they were waiting for the suburban train in Buenos Aires, Argentina; 795 people accepted and completed the survey. We asked: “In your opinion, should severance payment be increased, kept as it is, or reduced?” We find that the large majority of outsiders, including both unemployed and informal workers—defined as employees without access to health insurance through their employer, which is legally mandated in Argentina—support an increase in severance pay (Figure 3). Only 4% of the unemployed and 2% of the informal employees support a reduction in severance pay, again contradicting the predictions of the insider–outsider model.

Figure 3 Preferences of unemployed and informal employees with respect to severance pay in Argentina

Source: Authors’ own data collected at train stations in Buenos Aires, Argentina.

Of course, each of these data sources has limitations which are further discussed in Ronconi et al. (2019). But to our knowledge these are among the very few data sources in developing countries which directly ask workers about their preferences on specific aspects of EPL. At the very least, they call for more detailed empirical exploration of the presumption in the insider-outsider literature that labour regulations would be preferred by insiders but disliked by outsiders.

If there is a grain of truth in the empirical suggestion that outsiders might not be averse to regulations which would ostensibly favour the insiders, why might this be the case? We consider a range of possibilities. The most straightforward option is the fact that the canonical insider-outsider model features a competitive labour market. Hence, a natural conflict arises between insiders and outsiders as demand for labour falls with labour regulation such as a minimum wage. However, it is by now well understood that with employer power a minimum wage, for example, can increase both wages and employment, thus creating no conflict at all (Stigler 1946, Manning 2005, Basu et al. 2010, Bhorat et al. 2017).

However, even with a competitive labour market, a broader perspective than that adopted by the insider-outsider literature might explain why outsiders might prefer regulation. Consider, for example, the minimum wage in a setting with income sharing between outsiders and insiders. In the extreme case where all labour income is equally divided between workers, whether employed or unemployed, it is the total wage bill that matters. With a minimum wage, the total wage bill increases when the elasticity of labour demand is less than one (the empirically relevant case). But even with incomplete sharing, for example when sharing between insiders and outsiders happens only within a household, it can still be in the interests of outsiders to prefer the minimum wage (Fields and Kanbur 2007).

But even without sharing between insiders and outsiders at a given point in time, a similar argument can be made over time if an individual faces the prospect of transitioning from outsider to insider status. The idea of optimistic outsiders is in line with more general propositions of subjective prospects of upward mobility (Bénabou and Tirole 2006, Alesina et al. 2018) and has important empirical support (Spinnewijn 2015). It would then not be entirely surprising that a current outsider might prefer a regulation policy which appears to favour current insiders, because this individual might one day be an insider himself or herself. While such transitions are not very common -- for example Anton et al. (2012, Table 3) report that for Mexico, between 2007 and 2008, only 11% of all workers changed status between formality and informality -- this perspective could nevertheless be part of the explanation for outsider’s preferences for regulation.

These and other possible explanations such as partial enforcement, behavioural economics and capitalist political power are considered in our paper (Roconi et al. 2019). The above arguments show that going beyond the straight jacket of the conventional insider-outsider perspective can open up many interesting areas of research, analysis and policy.


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