Institutional barriers in labor markets: Examples, impacts, and policies

Abstract

This paper examines the institutional biases that impede the competitive functioning of labor markets. Two contexts are considered. The first relates to Moroccan labor migrants in The Netherlands, where institutional bias distorts the competitive functioning of the labor market by downgrading the educational returns to migrant workers and acting as a disincentive for further investment in human capital. The second relates to labor markets in Indonesia and Pakistan. Institutional bias in these two countries leads to an exaggeration of labor returns to certified education, and to over-investment in university education. We argue that such biases are fed by misinformed beliefs and group interests, and stand in the way of achieving higher growth and equity.

Introduction

It is now established by North [1] that the relationship between institutions and good governance on one hand and the socio-economic development mechanism on the other hand, is essential for understanding growth. The shape of causalities is controversial, however. On the one hand, there is theoretical reasoning and empirical evidence supporting the hypothesis that the establishment of institutions has been a cause for promoting higher economic growth, Acemoglu [2]. At the same time, there is the hypothesis, with empirical support, that economic growth precedes the establishment and maintenance of institutions and good governance. Institutions and governance are then motivated by the goal to create and maintain equity, protect property rights, and sustain economic growth, (see Chong [3]), but institutions and governance are sometimes also arranged by regulatory capture, and are sought to exclusively protect specific interest groups, (see North [4]).

In these deliberations, analysts conceive institutions to foster rules of conduct that emphasize good governance. For instance, The World Bank identifies six indicators to measure ‘good governance’. They include: Voice and accountability, political stability, government effectiveness, regulatory quality, rule of law, and control of corruption. There is thus one opinion that countries within which agents, believe in and, practice good governance, achieve higher levels of socio-economic development. Yet, the other alternative opinion, Morck [5], is that higher levels of socio-economic development arise first, and if not driven by good governance, as a result of powerful interest groups, becomes a condition for preserving and sustaining inequity.

Much less attention has been given to the analysis of the functioning and impact of institutions that foster bad or poor governance, with the exception of corruption in transition and developing countries, as done by Anderson [6]. The current paper thus deals with an additional type of poor governance; one that emanates from institutional distortions in the labor market. Such distortions take the form of differentiated access to otherwise equivalent workers, and sub-remuneration of less-favored workers. For example, workers with the same productive ability, but identified as belonging to a less-favored ethnic group, likely face less freedom of entry and exit, and are often sub-remunerated.

In a similar vein, graduates with equally productive abilities may experience discriminatory career development and pay levels depending on the graduate school brand/label with which they are identified. Where/when they occur, ethnic and certification syndromes strengthen segmentation of the labor market, may very well cause an inefficient allocation of human resources, as well as reduce economic growth and increase income inequalities.

In this paper, we examine institutional shortcomings emanating from poor governance in two different contexts. The first relates to migrant workers in a segmented market; in particular, Moroccan labor migrants in The Netherlands. We purport that the institutional bias in this context distorts the competitive functioning of the labor market by downgrading educational returns to migrant workers, and acts as a disincentive for further investment in human capital.

The second context relates to the so-called certification syndrome in developing countries. We consider the labor markets in Indonesia and Pakistan as case studies. The institutional bias in these countries leads to an exaggeration of labor returns to, and an over-investment in, university education.

Although the two contexts examined here involve studies undertaken several years ago, institutional biases and their implication for growth, are still gaining more attention and validity. In particular, the interest of economists and policymakers in various aspects of inequality, redistribution and growth, and governance, has generated remarkable insights recently as found in Aghion [7], thus increasing the value of this study.

While the first case will demonstrate how institutional bias and poor governance can lead to under investment in human resource development, the second suggests the opposite, i.e., an over-investment in human resources. In both cases, it will be shown that the behavior of agents (employers and workers with varying backgrounds), may lead to detrimental effects on growth and equity.

The distorted behavior of the responsible agents, due to bad governance, is usually supported by the belief that the labor market is segmented and consists of sub-groups of workers which are appraised and remunerated differently, (see Baldwin [8], [9]). A form of discrimination is thus realized despite the fact that the worker segments can be shown to possess equal productive abilities as others. In the absence of good governance, and the existence of powerful group interest, assumptions and outcomes of inequality then coincide and result in each other reinforcement and justify reproduction of inequality.

While good governance is generally associated with corporate performance and sustainable growth and equity, Mueler [10], poor governance in a labor market normally suggests the opposite, Dunford [11]. Bad governance translates in regulatory capture, protects interest groups and result in rent-seeking and reproduction of inequality.

Central to this debate are labor market institutional shortcomings, and the ways they produce distortions and market failures. The next sections will underpin such shortcomings in two independent cases; the Netherlands and Indonesia and Pakistan.

Section 2 discusses the case where institutional bias leads to the underrating of educational returns for migrants in the Netherlands. Section 3 discusses the case of Indonesia and Pakistan where institutional bias is shown to result in the overrating of educational returns. Section 4 discusses the implications of these institutional shortcomings.