How misdirected labor policies led to high unemployment and underemployment

The topic of unemployment and underemployment in last week’s column is the backdrop for today’s focus on labor market policies. Labor policies have

muddied the road toward progress in improving wages and living standards for all workers. As a result, the escape from poverty has become more difficult.

“Labor policies in development.” Wise development policies require an imaginative use of both capital and labor as the main factors of production.

In terms of labor policies, the size of the labor supply that seeks good jobs should serve as a firm guide for generating jobs on the demand side. The collective mistake was the government’s populist emphasis on the protection of those already with jobs, thereby constricting demand growth for new jobs.

When the Bell Mission (1952) recommended the high minimum wage, the rationale was to give the workers “income and purchasing power” in order to provide a high consumption base for the economy. Over time, the same minimum wage policy was maintained as a means of guaranteeing that a “living wage” was essential and that the state would “protect labor from exploitation by employers.”

East Asian countries, on their way to growth, used the minimum wage (when they devised one) mainly to delineate an “entry wage” to hire new workers. This assured that they could encourage businesses to grow while providing more employment to those who seek work.

Now, employment is of course superior to unemployment. When employed at a wage rate however low, the worker has the means to sustain his needs and further provides him an opening to increase his income through new skills gained. That raises his productivity at work, a road toward his own prosperity.

Without employment, a worker has no income, becomes less adroit and therefore wasted, and is likely to be financially dependent on someone else (the family or a ward of society). Otherwise, the worker finds entrapment as a part of the underemployed in the informal economy.

Philippine labor policies have of course evolved in character and sophistication over time. However, instead of becoming more in line with the reality of the country’s inexhaustible labor pool, the government devised more and more rules to protect the already employed. In the process, rules of work became more and more rigid for those employed and for businesses.

Enterprises were subjected to elaborate and strict rules before they could remove unwanted workers. A plethora of rising state regulations required mandated rises in incomes and subsidies (cost of living adjustments; 13th month pay; holidays and holiday pay; etc.). The state prohibited prolonged casual employment – an escape route from the high minimum wage and other kinds of mandated salary increases – by forcing the regularization of employments of longer than six months.

Subjected to such rules, enterprises in the country responded with ways to avoid raising their regular payroll sizes. A new industry of labor contracting was born that took away direct labor hires. Firms in organized business, to avoid the imposed costs of manpower that would enter the regular payroll, made moves to subcontract their labor hiring. Large firms with large payrolls became leaner companies with smaller regular payroll but larger labor hires of a tentative nature.

Thus also, the labor subcontracting industry became a dominant force in the labor market allocation of workers. Subcontracting of labor of less than six months became a regular feature of the labor market. Employment became more cyclical and short term for workers. The direct connection between firms and workers were cut. Unemployment became a predictable pattern for a lot of workers.

“Direct outcomes on economic growth, on employment, and on sector growth.” The labor policies worked to reduce the process of hiring more workers in organized business. Rather than encouraging the inflow of foreign direct enterprises that specialized in labor-intensive processes, many of these businesses chose to locate in other countries.

Below, I use throughout for consistency the calculations reported by the World Bank in the report on the Philippines cited last week.

Over the decades, the Philippine output grew only by 1.5 percent per year. Such growth performance compared poorly with the highly developing countries of East and Southeast Asia (notably South Korea, Malaysia, China, Taiwan, Hong Kong, Singapore, and China). These countries expanded by at least six percent per year – more than four times than ours.

“Labor productivity and ‘total factor productivity.’” Measures of productivity provide a better micro-picture of this economic performance.

In terms of labor productivity (or output per worker), Philippine annual growth was only one percent. The collective annual growth for East Asian countries (including the ASEAN countries mentioned) was 4.4 percent.

Using “total factor productivity” – a measure showing the combined productivity brought about by the factors of production – the picture looked grimmer. The Philippines was uniquely the only country with a negative annual figure for total factor productivity. This finding is not a new number. Work notably of Richard Hooley and later by Cesar Cororaton at at the Philippine Institute for Development Studies had chronicled it before.

“Jobless growth, or growth with few jobs” The response of employment growth arising from a one-percent growth of output is also measured. Economists have a name for this, “elasticity of employment.”

The numbers for 1997 to 2010 are quite revealing: for agricutlure is 0.42, for industry 0.34 and for services 0.66. These numbers mean that a one percent of growth of the economy leads to a less than one percent growth of employment.

Note that industry’s elasticity of employment (0.34) is only one third of one percent. A separate measure of the elasticity of manufacturing is even much lower, about one-fifths of one percent on GDP growth! Ideally, a growth strategy that helps to wipe out unemployment should have an elasticity measure that is close one.

There are informational imperfections and technical issues involved in these measures. But they provide alarming orders of magnitude that should concern all those who want to reduce unemployment issue in the country.

(Next week: How to reverse the employment outcomes with a reform of labor policies.)

My email is: gpsicat@gmail.com. Visit this site for more information, feedback and commentary: http://econ.upd.edu.ph/gpsicat/