III. Mauritian Labor Market Institutions and Low Employment8
51. Notwithstanding impressive economic growth, Mauritian unemployment has increased in every year since 1991, with the unemployment rate reaching 10.2 percent in 2003. As in many countries, this unemployment is primarily experienced by low-skill workers.9 In response to this growing unemployment problem, the government has begun to address the problem of apparent skills mismatch through far-reaching educational reforms.10 However, as shown in this paper, educational reform can only be a partial solution to the unemployment problem.
52. In the face of strong economic growth, such an increase in unemployment suggests the root of the problem could lie in Mauritius’s labor market institutions. These institutions—which compress the wage distribution and limit the ability of employer’s to redeploy their workers—may have seriously impaired the functioning of the labor market. While they may not have resulted in significant unemployment in earlier decades, the increasing importance of (high-wage) service sectors in Mauritius, which have increased the impact of cross-market wage compression, as well as the gradual decline in the demand for low-skill workers, will probably exacerbate the impact of these institutions.
53. The impact of these restrictions will become increasingly detrimental as Mauritius faces significant structural challenges—considerably changing the market for low-skill workers—in coming years. The most significant of these challenges is the eventual loss of preferential arrangements for its sugar and textile exports. While it is still uncertain when the preferential sugar regime will end, Mauritius’s quota under the Agreement on Textiles and Clothing (ATC) is set to lapse by end-2004. Although the preferential access granted under the U.S. African Growth and Opportunity Act (AGOA) may mitigate some of this impact, the Mauritian economy will undoubtedly go through a period of restructuring, as the textile sector adjusts to its new environment. As discussed in Section B, signs of adjustment are already evident in the textiles industry. Changes in the demand for sugar workers have already begun with the government’s Sugar Sector Strategy, which has reduced employment by around a quarter. By delaying reform of its labor market institutions, Mauritius will exacerbate the pain involved in this adjustment, especially for those with few skills.
54. In light of these challenges, this paper analyzes the market for low-skill workers, who risk being neglected as the government focuses on developing other sectors. With the export processing zone (EPZ) being an important source of low-skill employment, the paper first investigates the evolution of this sector (in Section B). In Section C, a simple stylized model of the job creation and destruction processes is employed to assess the potential benefits of labor market reform. The results suggest that even relatively minor wage compression and restrictions on the redeployment of workers can have dramatic impacts on the fragility of jobs, and the extent of unemployment and labor market churning.11
55. As such, this paper complements the work of McDonald and Yao (2003), who looked at the impact of Mauritius’s institutions on the prospects for developing new sectors, and the consequent labor market transition. This paper concentrates on how these institutions impact on the prospects for low-skill workers by changing the incentives to create and destroy jobs—in both new as well as existing areas—that they are able to perform. With these workers the most likely to suffer from the structural transformation, deregulation could potentially improve the labor market conditions these workers face in a relatively short space of time.
Mauritius’s labor market institutions
56. The Mauritian labor market is highly regulated, with wages and conditions of employment determined centrally rather than at the firm level. The government establishes a separate set of labor market regulations, called Remuneration Orders (RO), for each industry.12 These regulations specify the exact duties of every type of worker in great detail. With these regulations being aggressively enforced by the Ministry of Labor, worker redeployment is extremely difficult. Therefore, wages and conditions do not reflect the productivity or circumstances of individual firms. Moreover, terminations tend to be costly and time consuming, requiring approval of the Termination of Contracts Services Board, and often leading to delays on the order of four months.
57. The centralized wage determination process tends to compress the wage distribution. Basic wages for each occupation are set in the RO, with the annual tri-partite wage-setting process resulting in a new wage for all categories. In most years this process results in wage growth indexed to inflation, with lower wages rising by more than higher ones. Once every five years, the Pay Research Bureau establishes a catch-up wage increase for the public sector, which typically puts some additional pressure on private sector wages.
58. The ability of the economy to adjust in the face of its structural challenges will be inhibited by these regulations (Section C). With wages being compressed and workers unable to be redeployed as circumstances change, jobs become substantially more fragile. Moreover, the incentive to create new jobs can also be reduced significantly. Therefore, even with the government encouraging the creation of new industries, such as the information, communication, and technology (ICT) sector, many of these opportunities, at least for some time, may bypass much of Mauritius’s low-skill workforce. Employment opportunities for these workers can be enhanced over the medium term by simply liberalizing the regulations that govern the labor market.
B. Evolution of Employment in the EPZ (Textiles) Sector13
59. Textile production, especially in the EPZ sector, has contributed significantly to the Mauritian “growth miracle.”Figure III.1 shows the decomposition of EPZ employment growth into its separate components—job creation and job destruction—since 1983.14 This figure shows the remarkable transformation that occurred in the early 1980s, before the extent of job creation and destruction stabilized around their longer-term values. This figure also shows that the creation and destruction of jobs is a persistent and continual process of renewal, with sizable job destruction occurring even during periods of high employment growth. This continual creation and destruction suggests substantial “reallocation” of activity across firms within the EPZ sector. Figure III.2, which depicts the job reallocation and excess job reallocation rates, shows that the exceptional job reallocation seen initially, reflecting the rapid creation of new EPZ sector jobs during the early-1980s, subsequently declined as the industry matured.15 As measured by the excess job reallocation rate, the extent of churning in the labor market also declined as the industry matured.
Figure III.1.Decomposition of Annual EPZ Employment Growth, 1982-2002
Sources: Central Statistical Office, Mauritius, and staff estimates.
Figure III.2.Annual EPZ Employment Growth and Reallocation Rates, 1983-2002
Sources: Central Statistical Office, Mauritius, and staff estimates.
60. Quarterly job creation and destruction data show signs of a weakening in textiles during 2003. Figure III.3 shows the quarterly decomposition of employment growth (from March 1986 to September 2003), and is analogous to Figure III.1. This figure also shows the rapid growth in EPZ employment in the mid-1980s, before a moderation in employment growth took place throughout the 1990s. However, the data for the first three quarters of 2003 show a substantial decline in the rate of job creation (to its lowest level ever), and a rapid increase in the rate of job destruction. In addition, Figure III.4 shows a marked increase in the average size of firms closing down in the last two years. Although relatively recent, the dramatic nature of the increase in job destruction and the decline in job creation in the last year would be consistent with a rapid structural decline in Mauritian textiles. While the industry is unlikely to—even in the long-run—disappear completely, it could very well be much smaller in the coming years.
Figure III.3.Decomposition of Quarterly EPZ Employment Growth, 1986-2003 1/
1/ Seasonally Adjusted.
Sources: Central Statistical Office, Mauritius, and staff estimates.
Figure III.4.Average Size of New and Closing Firms, 1986-2002
Sources: Central Statistical Office, Mauritius, and staff estimates.
61. Mauritius’s restrictive labor market institutions mean that it shares many characteristics with other highly regulated labor markets, such as those in western Europe. In addition to Mauritius’s relatively high unemployment, unemployed workers face exceptionally long spells, with an average (median) unemployment duration of 20 (9) months. Moreover, consistent with the stagnant nature of the unemployment pool, Mauritius has relatively low rates of job flows. Table III.1 compares the rates of job creation and destruction in the U.S., Portuguese manufacturing, and the Mauritian EPZ sector (which is predominantly textiles). The Mauritian and Portuguese labor markets tend to exhibit much smaller quarterly job flows than seen in the U.S., suggesting they are less dynamic than the relatively unregulated U.S. one. That is, flows of workers into and out of unemployment seem much less frequent, thereby leaving the unemployed stranded for longer.
|Country||Sector||Job Creation||Job Destruction|
|Apparel and Textiles||4.58||5.40|
Compared with U.S. manufacturing sector.
Compared with U.S. apparel and textile ssectors.
Compared with U.S. manufacturing sector.
Compared with U.S. apparel and textile ssectors.
C. An Assessment of the Impact of Wage Setting and Redeployment Restrictions
62. This section investigates the impact of labor market institutions that compress wages and inhibit the redeployment of workers by using a calibrated version of a simple labor market-matching model. It finds that even relatively small distortions can have substantial effects on employment. One advantage of the type of model employed here is that it explicitly captures the frictional nature of labor markets. The model used in this section is specifically chosen to emphasize the effect of institutions on the creation and destruction of jobs and unemployment. The structure of the model used in this exercise is fairly standard, being that developed by Pissarides (2000) and Mortensen and Pissarides (1994). The impact of Mauritius’s labor market institutions will be assessed using a calibrated version of this model.16
63. The structure of the model economy is one where a large number of entrepreneurs can create job openings whenever it is profitable. Once created, the entrepreneur searches for a worker to fill the position which, depending on the extent of frictions in the market, may be very difficult and time consuming. When a worker and an entrepreneur meet, they, if allowed, bargain over the wage and decide whether to work together, thereby creating a job. However, if the government legally imposes the wage to be paid, production only occurs if profitable at that given wage. The profitability of these jobs evolves in a persistent manner over time, reflecting changes in demand and technology. If, as a result of this evolution, the job becomes unprofitable, the entrepreneur will destroy it and possibly create a new job opening, while the worker becomes unemployed and is able to search again.
64. The solution of this stylized model may be represented in a diagram. The endogenous equilibrium creation and destruction decisions can be neatly summarized by two elements: the reservation productivity, below which the match is destroyed (εd); and the extent of labor market tightness—defined as the ratio of vacancies to the number of unemployed (
Figure III.5.The Impact of Labor Market Institutions
65. The simple nature of this stylized model means that the impact of policies and institutions can easily be studied. For the questions considered in this section, two comparative statics are relevant: (i) the impact of an exogenous compression in the wages relative to the results of bargaining; and (ii) the impact of limits on the ability to redeploy workers.
66. The qualitative impact of wage compression on the creation and destruction decisions of firms is clearly shown in Figure III.5(a). First, raising the average wage paid to low-skill workers, especially the wages of the lowest paid, makes the most “marginal” jobs unprofitable, resulting in their destruction. Therefore, the productivity of the marginal job, εd, must rise, increasing the total amount of destruction (the JD curve moves right). There is a slightly off-setting effect on job creation. Since all new jobs are assumed to begin with high productivity in this model, and as relative wage compression reduces the relative wage paid in higher wage jobs, the incentive to create new jobs (at the same time as destroy old jobs) rises slightly (the JC curve moves right). In aggregate, more jobs are destroyed, and fewer jobs are typically created.
67. The impact of restrictions on the flexibility of workers have very intuitive effects, which are shown in Figure III.5(b).18 By reducing the expected output of a worker in any given period, keeping workers in the more marginal jobs is no longer profitable (and so the JD curve moves right). Reflecting the increasing fragility of jobs, the destruction of jobs increases, as does the creation of new jobs.
68. These effects are quite general and apply beyond the EPZ sector. In particular, even if some sectors are granted a preferential regulatory environment, the opportunities for low-skill workers will still be unnecessarily restricted. Indeed, as the structure of the economy and the demand for low-skill workers changes over the coming years, the differential regulatory treatment could become increasingly detrimental.
69. To make this analysis more concrete, this stylized model of job creation and destruction is calibrated to salient features of the Mauritian economy. In particular, the model is calibrated to match the average EPZ job destruction rate following the establishment of the sector (1989-2002), and the unemployment rate for low-skill workers recorded in the 2000 census (of 9.6 percent).19 Finally, the parameters are chosen so that a reasonable degree of labor market tightness would result in a decentralized bargaining market. The baseline results are reported in Table III.2. While Mauritius’s labor market institutions undoubtedly compress wages, there is unfortunately no concrete measure of the degree of this compression.20 Therefore, in this baseline calibration, we assume a small amount of “bleeding” of wages from high-wage sectors to low-wage workers (i.e., average low-skill wages are about 2 percent higher than what they would be under decentralized wage bargaining), as well as some moderate compression of wages paid within low-skill industries consistent with the cross-market effect.
|No Wage Compression|
|10 percent lower|
|Percent Difference benchmark||4.1||3.7||-3.5||0.8||-0.5||0.7|
|10 percent lower redeployment rate||9.9||11.8||36.7||4.0||0.88||8.1|
|Percent Difference no|
70. Even with these minimal assumptions, there is a noticeable impact on unemployment, the average length of an unemployment spell, and—although to a lesser extent—unit labor costs. All of the policy experiments are performed relative to an environment where firm-level wage bargaining is the norm. Table III.2 reveals a significant increase in unemployment, as well as the average length of unemployment spells. These changes reflect a significant reduction in the creation of new jobs—evidenced by the 17 percent fall in the job finding rate—and an increase in job fragility—seen in the rate of job destruction. Even small amounts of wage compression can, therefore, lead to a significant reduction in the welfare of workers (and employers). A move to firm-level wage bargaining could bring significant benefits to these workers. While wage compression also tends to increase unit labor costs, it has a relatively minor impact because wage compression leads to the closure of the less productive jobs, raising average productivity.
71. While both types of wage compression are costly, cross-market compression seems more harmful. Removing the cross-market compression leads to a much larger reduction in unemployment, than removing the within-market compression. Reflecting its immediate effect on profitability, removing the cross-market compression leads to a big increase in the rate of job creation, and a small reduction in the job destruction. Removing the assumed amount of within-market compression has a smaller effect on the creation of new jobs, but leads to a bigger fall in the fragility of existing jobs as it has a bigger impact on the profitability of the most marginal jobs.
72. A small reduction in the ability of firms to redeploy workers also leads to an increase in unemployment, and the length of average unemployment spells. In this exercise it is assumed that such regulations result in a 10 percent reduction in the level of output. The increases in unemployment and unemployment duration reflect increases in the fragility of jobs (an increase in job destruction), as well as a lower job finding rate given the fall in profitability. Table III.2 also shows that wage compression significantly worsens the impact of these employment restrictions, with these restrictions resulting in a 4.1 percent rise in unemployment in the absence of wage setting restrictions, and a 34.2 percent rise in unemployment with such restrictions.
73. Figures III.6–III.8 show the consequences of various degrees of wage compression and employment restrictions for labor market outcomes, as we move from an undistorted equilibrium in which firms and workers are free to bargain over wages. Figure III.6 shows the impact of cross-market compression up to a 5 percent increase in average wages. Figure III.7 shows the impact of increasing within-market wage compression, so that average wages remain relatively unchanged. Figure III.8 shows the effect of reducing the difficulty of redeploying workers, as reflected in an increase in expected output.
Figure III.6:Cross-Market Wage Compression: Unemployment and Job Destruction Figure III.7:Within-Market Wage Compression: Unemployment and Job Destruction Figure III.8:Worker Redeployment: Unemployment and Job Destruction
- Increases in the extent of cross-market wage compression lead to monotonic increases in unemployment and the fragility of jobs. Although not shown, they also increase the length of the average unemployment spell and the extent of inefficient churning.
- Increases in the extent of within-market wage compression tend to increase unemployment and the fragility of jobs. There is also an increase in the extent of inefficient churning, and the average duration of each job falls by over 10 percent. For very high amounts of wage compression, there is a slight reduction in unemployment reflecting the fact that—given the assumption that new jobs are created with the highest level of productivity—higher within-market wages tend to increase the job-finding rate.
- Increases in the ability to redeploy workers significantly reduce unemployment and job fragility. Although not shown, the average length of unemployment spells and the extent of inefficient churning also fall. Moreover, all these improvements are greater when wages are not compressed.
74. Wage compression significantly worsens the impact of negative shocks. As can be seen from Table III.2, the impact of a 10 percent reduction in the level of output significantly increases the extent of unemployment and the length of unemployment spells. With the main employers of low-skill workers undergoing significant changes in coming years, reform to these wage setting institutions will become increasingly important.
75. Sectors that intensively employ low-skilled workers, such as sugar and EPZ, have contributed significantly to the Mauritian “growth miracle” (Subramanian and Roy, 2001). The rapid economic transformation that resulted from the EPZ sector creation is clearly seen in Figures III.1 and III.2. However, in the face of impending changes in these markets, low-skill workers will face very different employment prospects in the coming years.
Indeed, the evidence presented in Section B suggests these changes, at least for textile workers, have already begun. Therefore, the need for labor market reform is now urgent.
76. While several factors have contributed to the incidence of unemployment in Mauritius, the results of a simple modeling exercise show that wage compression and redeployment restrictions reduce the employment of the affected workers and increase the length of the resulting unemployment spells. Moreover, all of these policies result in excessive turnover in the economy, which will ultimately reduce the ability of workers to acquire skills when employed and hasten their atrophy when workers become unemployed. Indeed, the harm resulting from any of these distortions is intensified when other distortions coexist. Moreover, wage compression imposes costs beyond those discussed in this paper. As Haltiwanger and Vodopivec (2002, p. 5) find in their study on Slovenia, “... businesses with more compressed wages have ... greater excess turnover for high quality workers, ... [and] wage compression creates excessive instability of jobs and imposes additional worker dislocation costs, as well as reduces firms’ ability to achieve quality firm-worker matches.”
77. Shielding some sectors from restrictive institutions may ameliorate the effects temporarily, but ultimately these distortions will harm the opportunities for low-skill workers and, more broadly, longer-term growth prospects. By distorting the incentives to reallocate economic activity into new, unimagined areas, these institutions limit the opportunities for low-skill workers and inhibit the reshaping of the economy. This will become increasingly so, as the economy undergoes an enforced structural transformation in the coming years.
78. While the government has embarked on a bold and essential series of educational reforms, general labor market reform remains crucial. These educational reforms will undoubtedly help Mauritius move into other high-tech fields, but will not be able to assist all low-skill workers. First, these educational reforms will take some time to bear fruit. Second, with only 7.3 percent of Mauritians having their higher school certificate, it will take considerable time before these new endeavors can absorb much of Mauritius’s low-skilled labor force. Therefore, educational reform can, at most, be only a partial solution to the unemployment problem.
The model is populated with entrepreneurs, who are able to create jobs. In this paper we assume that entrepreneurs can choose ex ante to search for either a domestic low-skill worker, or separately for a foreign worker. This, in effect, segments the low-skilled labor market into two separate markets, meaning that the analytical structure is applicable to both, and the markets may be considered separately. An entrepreneur will attempt to create a job by posting a vacancy whenever it is profitable to do so, meaning that the equilibrium number of vacancies posted is determined by a zero profit condition
where k is the cost of posting the vacancy, q(.)is the rate at which entrepreneurs meet searching workers, is the discount factor, and J(ε) is the value received by the entrepreneur from being matched with a worker. As mentioned in the text, these jobs are subject to idiosyncratic uncertainty, captured by the shock ε, which makes its value change. However, all new matches begin with the highest value of
where f (ε) is the output generated by the match, w(ε) is the negotiated wage, and γ is the probability that the job will be subject to a change in its output. If the value of continuing with the worker in this current position falls below zero, the match is destroyed. The shock, ε, is drawn from a distribution, F(ε). Although somewhat nonstandard, the process for idiosyncratic productivity defines a persistent stochastic process.
The value of working for an employed worker is given by an analogous Bellman equation to (A2)
where the Emax operator reflects the fact that the wage bargain means that the worker and entrepreneur agree on the whether the match should continue. An unemployed worker generates a value that reflects the value that accrues to forming a match with an entrepreneur
where p(.) is the probability that an unemployed worker receives a job offer.
The costly and time consuming matching process is assumed to be represented in a very stylized way, with the number of matches formed in any period being a function of the number of vacancies and unemployed workers, m(u, v). As is common, we assume this is a constant returns-to-scale function, meaning the job- and worker-finding rates only depend on the tightness of the labor market. Given all of this, the finding rates can be represented by:
The bargain process is assumed to satisfy the Nash axiomatic solution, meaning that wages paid must be sufficient so that workers receive their value for searching, plus a share (equal to their bargaining power, θ) of the “surplus” generated by the match, i.e., Ve(ε)= Vu+θ[J(ε)+Ve(ε)–Vu]. Using these conditions, one can derive the conditions for job creation and destruction in the case that wages are determined by decentralized bargaining, with the equilibrium resembling that in Figure 5, except that the JD relation is upward sloping (Mortensen and Pissarides, 1994). Hosios (1990) shows that, given the matching frictions, only when the elasticity of the matching function with respect to vacancies equals θ is the equilibrium efficient. The equilibrium creation and destruction decision rules
In the case where the government imposes a wage schedule that is not bargained,
The resulting equilibrium creation and destruction decision rules, and the expressions underlying the JC and JD curves in Figure 5 are, therefore,
It is easy to show that for linear production functions, the equilibrium wage function (w(ε)) will be linear in productivity: w(ε) = w0+w1ε. The wage compression assumed in this paper assumes that, for a constant distribution of productivity across jobs, average wages grow by g percent and the slope of the wage schedule becomes flatter by a factor φ (φ = 1 means no within-market compression). This means that the assumed compressed wage schedule is
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Prepared by Nathan Porter.
The 2000 Census reported that 90 percent of the unemployed have not completed the high school certificate.
A common measure of mismatch in the labor market—the variance of relative unemployment rates across categories—suggests that mismatch may have actually declined between the 1990 and 2000 censuses. Using labor market data by educational category, the variance of relative unemployment rates has declined from 17 percent to 12 percent. The intuition for this measure is that the greater the dispersion in unemployment rates, the greater the mismatch in the labor market (Layard, Nickell, and Jackman, 1991, Ch. 6).
In this context, the fragility of a job refers to the likelihood it is destroyed. By relative wage compression we mean that—possibly due to centralized wage determination—the wages paid to workers are artificially more similar than they would be if wages were the result of firm-level bargaining (Bertola and Rogerson, 1997). This means that differential wages do not fully reflect differences in productivity or working conditions. More specifically, this could mean that wages in a particular sector are “linked” to wages in a higher paying sector (cross-market compression), and/or that wages within an industry are closer to each other, although the average wage is much the same (within-market compression). Invariably, both of these types of compression occur.
For example, the RO for the catering industry defines “assistant barman,” “barman,” and “head barman” as separate occupations, with each unable to perform the duties of the other—an “assistant barman” cannot prepare a drink if a “barman” is at the bar. These regulations do not cover the EPZ sector, and are not expected to cover new information, communications and technology (ICT) activity.
With textiles accounting for almost 90 percent of EPZ sector employment, textiles and EPZ will be referred to interchangeably in this section.
The job creation, destruction, and employment growth rates used in this section are calculated by dividing the change in employment between two periods by the average employment in those periods. While slightly different from the standard definition of growth rates, it is consistent with the definition typically applied in the job flows literature—see Davis, Haltiwanger, and Schuh (1997).
Following Davis, Haltiwanger, and Schuh (1997), the job reallocation rate is defined as the sum of job creation and destruction rates. This definition reflects the fact that reallocation of jobs and workers from one type of activity to another typically requires the creation of jobs at expanding enterprises and destruction of jobs at contracting ones. Defined in this way, job reallocation also equals the maximal reallocation of workers induced by the reshuffling of employment opportunities across enterprises. The excess job reallocation rate is defined as job reallocation in excess of absolute employment growth, indicating the reallocation of jobs above the amount required to accommodate net employment changes, and may be also thought of as a measure of “churning.”
This differs from the solution in the standard Mortensen and Pissarides (1994) model where wages are bargained. In that model, there is a negative relation underlying the JD curve, which reflects that a tighter labor market (higher
Since the ability of firms to redeploy workers reduces the value a firm can expect from a worker in any period, it is modeled as a reduction in the level of output expected in any period. That is, with some probability a worker may need to perform the duties of another occupational category. Since employment restrictions inhibit this redeployment, the worker is less valuable.
It is implicitly assumed that all low-skill jobs share the job destruction rate of the EPZ sector. In 2000 the overall unemployment rate was 8.8 percent.
For example, Mauritius does not have estimates of traditional measures of wage dispersion, such as the 90-10 wage differential, or the cross-sectional variance of wages paid.