6.8 Informality after labor market reforms in EMDEs

FIGURE 6.8 Informality after labor market reforms in EMDEs

Efforts to increase labor market flexibility and efficiency have been followed by declines in output informality.

A. Cumulative changes in output informality following a 1-point increase in Fraser Institute index of hiring and firing regulations in EMDEs

Percentage points of GDP 0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 -1.0

t = 2 t = 5

B. Cumulative response of output informality to a 1-point increase in WEF index of labor market efficiency in EMDEs

Percentage points of GDP 0.2 0.1 0.0 -0.1 -0.2 -0.3 -0.4 -0.5

t = 2 t = 5

Source: World Bank. Note: The labor market efficiency index from WEF measures the extent to which the labor market matches workers with the most suitable jobs for their skillset (1 = worst, 7 = best). The index on hiring and firing regulations is from the Fraser Institute, which measures the extent to which hiring and firing regulation are restricting economic freedom in the labor market (1 = worst, 10 = best). Data are for EMDEs over the period 1990-2018. DGE = dynamic general equilibrium model; EMDEs = emerging market and developing economies; WEF = World Economic Forum. A.B. Bars show the cumulative changes in DGE-based output informality in percent of GDP to a 1-point increase in the Fraser Institute’s index on hiring and firing regulations (1-point increase in WEF labor market efficiency index in B). Whiskers show the upper and lower bounds of the corresponding 90 percent confidence intervals. The results are obtained via a local projection method. Output informality in percent of GDP is detrended using Hodrick-Prescott filter. “t = n” indicates the cumulative changes in output informality over the n years after a policy change. See annex 6A for detailed model specifications.

hiring and dismissal of workers is at the employer’s discretion, was associated with a significant drop in output informality, by 0.5 percentage point, over the following five years. A 1-point increase in the World Economic Forum’s labor market efficiency index was associated with a cumulative drop in output informality by about 0.2 percentage point of GDP over the following five years.20 Firm start-up costs

More difficult firm start-up in more informal economies. Starting a new firm is more challenging in EMDEs with more pervasive informality (figure 6.9). On average, the costs of business start-up amount to about 90 percent of per capita gross national income (GNI) in EMDEs with above-median output informality—three times the level in other EMDEs. It takes 33 days to start a business in EMDEs with above-median informality— about 1 day longer than in other EMDEs, although the difference is not statistically significant. Over time, easier firm start-up. Business start-up costs have fallen steadily in EMDEs over the past two decades. Between 2003 and 2018, the costs of business start-up fell

20 A similarly sized increase in labor market efficiency was associated with a decline in employment informality by 2 percentage points of employment, cumulatively, over the following two to three years.