Labor Market Regulation and Youth Employment : Empirical Evidence from MENA Region

Introduction: Identifying the determinants of youth employment has a direct effect on enhancing productivity, knowing such determinants can facilitate the pathway for policymakers to deal with the challenges ahead. Youth employment in the MENA region is one of the lowest levels of employment in the world, which has weakened productivity in this region compared to other regions of the world. The hypothesis suggested by the neoclassical labor market theory is that the lower employment was due mainly to the presence of more stringent rules of the labor market, which represented an obstacle to achieving full employment. The neoclassical theoretical arguments in favor of higher labor market flexibility are based on the fact that labor market flexibilization is a key factor to enhance productivity, increase a firm’s competition in the market, increase economic growth and increase employment. In particular, it is possible to draw at least four reasons for why a high degree of rigidity in the labor market reduces the employment level: (1) the existence of stringent labor market rules determines that, in equilibrium, workers’ wages are higher than their marginal product, leading, in this way, to a misallocation of resources; (2) higher labor market rigidity represents an obstacle to the adjustment of the labor market determined by the changes of the business cycle; (3) the rigidity of labor markets represents an economic “rent” from the capital to labor that reduces the profitability of investors and discourages investment and economic growth; (4) finally, the rigidity of labor market institutions protects insider, preventing outsiders (especially young workers) from accessing the labor market. On the other hand, there are at least three arguments in opposition to the neoclassical labor market theory hypothesis that deserves to be analyzed. (1) higher deregulation does not contribute to an increase in youth employment, but it determines only a substitution effect, (that is, the substitution of typical employment with sub-protected workers); (2) policies aiming to provide greater flexibility in the labor market can have (maybe) some effect in the short run; but in the long run, they are harmful for innovation, economic growth and employment; (3) Labor market flexibility policies to reduce workers' wages have detrimental effects for firms because they lead to “adverse” selection regarding workers. Considering the theoretical arguments pro and con, the motivation that underlies this study is to try to evaluate whether the implementation of labor market flexibility has produced the desired effects on employment as stated by neoclassical theory or, vice versa, whether it is harmful to employment, as stated by heterodox scholars.

Methodology: In this study, we use the youth employment data and labor market regulation index in the MENA region from 2005 to 2019 and use the two-stage D-GMM estimator method as well as the two-stage SYS-GMM method to robustness the results, we examine the validity of the neoclassical hypothesis regarding the effect of flexibility on employment.

Results: Based on the obtained results, labor market regulations have a positive and statistically insignificant effect on youth employment, which does not provide evidence in support the neoclassical hypothesis. On the contrary, this research shows that economic growth and foreign direct investment have a positive and significant effect on youth employment. In the case of the inflation variable, the D-GMM estimator method shows a positive and significant effect and on the contrary, in the case of the population growth variable, the SYS-GMM estimator shows a significant negative effect.



Conclusion: The economic literature has suggested that higher labor market flexibility represents one of the main pillars to increase employment (youth). Indeed, a rigid labor market increases production costs for firms and reduces firms’ competitiveness in international markets, and as a result, production and employment are reduced. Considering the other variables in our empirical model, we find that growth contributes to increase youth employment. In this regard, it is worth spending some words on the effect of growth on youth employment. that economic growth allows for the increase youth employment is not news, Because this result over time has been confirmed empirically in several previous studies; rather, much discussion revolves around the debate of how to create an environment favorable for economic growth. One of the most important factors that can create a suitable environment for economic growth is improving competitiveness in the market. One of the ways to improve competitiveness is to increase the flexibility of the labor market through; (1) the introduction of “atypical” jobs (fixed and part-time contracts) to facilitate the entry of young people into the labor market; (2) lowering of the hiring and firing costs, allowing firms to increase their competitiveness on international markets and adjust the labor demand according to the business; (3) reducing employment security, aiming to reduce the protection that insider workers enjoy, preventing the labor market segmentation described by insider-outsider theory; (4) reducing the dominance of the public sector, or in other words, the development of a private sector, which is very important for job creation. The dominant role of the public sector as an employer throughout MENA has distorted labor market and diverted resources from dynamic private sector. On the other hand, government hiring practices typically placed a premium on diplomas over actual skills and contributing to skill mismatches. Another tool that can increase the flexibility and efficiency of the labor market and thus economic growth is the appropriate investment in active labor market policies, which have been growing in recent years in developing countries. Because governments of these economies increasingly see ALMPs as a tool capable of both improving labor market efficiency and increasing growth. Active labor market policies can be growth–increasing through higher average productivity in the economy, by helping workers to find jobs that are better suited to their skills and experience, encouraging skill acquisition and human capital development, improving participants' employability, and reducing information asymmetry in the job-search process, and also raising the average job-matching rate.



Keywords: Flexibility, Youth Employment, D-GMM