Do Labor Market Regulations Affect Labor Earnings in Ecuador?

Although Ecuador may have the most cumbersome labor market regulations in Latin America, these are not a major source of segmentation of the labor market. The reason: the benefits mandated are fully fungible with wages.Ecuadorian labor costs are said to be high because of a large array of mandated benefits. But there are several reasons to doubt that labor market regulations, cumbersome as they are, are responsible for segmentation of the labor market, let alone slow growth and increased inequality. And available evidence on the regulations' impact on the labor market is not compelling, as MacIsaac and Rama show.Using the 1994 Living Standards Measurement Survey, they show that the impact of mandated benefits is mitigated by a reduction of the base earnings on which they are calculated. Therefore, Ecuador's labor regulations do raise take-home pay, but less than the vast number of benefits would suggest. The increase in labor costs induced by compliance with labor regulations is even smaller than the corresponding increase in take-home pay, because mandated benefits are not subject to social security contributions or payroll taxes.Despite mandated benefits, wage differentials between industries are comparable to those in Bolivia, a country otherwise similar to Ecuador, yet known to have flexible labor markets.Cumbersome as they are, Ecuador`s labor market regulations cannot be held responsible for most labor market segmentation. Compliance with these regulations is associated with significantly higher take-home pay only in the public sector and where trade unions are active - and it is unclear that merely changing the labor code would bring wages down in those two areas.And the most dramatic earnings gap, the one between jobs in agriculture and the rest of the economy, appears to be largely independent of either unions or labor laws. Drastically streamlining the labor laws would be welcome, but only moderate change should be expected from such a reform.This paper is a product of the Poverty and Human Resources Division, Policy Research Department. The research was initiated in the context of a poverty assessment for Ecuador undertaken by Country Department III, Latin America and the Caribbean. The study was funded by the Bank's Research Support Budget under research project The Impact of Labor Market Policies and Institutions on Economic Performance (RPO 680-96)