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

Document Type : Research Paper

Authors

1 PhD Student in Economics, Tarbiat Modares University, Tehran, Iran.

2 Professor in Economics,Yazd University, Yazd, Iran.

3 Assistant Professor in Economics, Tarbiat Modares University, Tehran, Iran.

Abstract

Purpose: Identifying the determinants of youth employment has a direct effect on enhancing productivity, and knowing such determinants can facilitate it 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 is mainly due to the presence of more stringent rules of the labor market which pose an obstacle to achieving full employment. 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 the competition of firms in the market, and increase economic growth and employment. In particular, it is possible to express at least four reasons as why a high degree of rigidity in the labor market reduces the employment level. They are a) the existence of stringent labor market rules determines that, in equilibrium conditions, workers’ wages be higher than their marginal product, thus leading to the misallocation of resources, b) higher labor market rigidity poses an obstacle to the adjustment of the labor market determined by the changes of the business cycle, c) the rigidity of labor markets induces economic rents from the capital to labor, which reduces the profitability of investors and discourages investment and economic growth, and d) the rigidity of labor market institutions protects insiders and prevents 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 hypothesis. They include a) higher deregulation does not contribute to an increase in youth employment, but it exerts only a substitution effect, e.g. the substitution of typical employment with sub-protected workers, b) policies aiming to provide greater flexibility in the labor market may have some effect in the short run, but, in the long run, they are harmful for innovation, economic growth and employment, c) labor market flexibility policies to reduce workers' wage have detrimental effects on firms because they lead to adverse selection regarding workers. Considering the theoretical arguments pro and con, the motivation for this study is to evaluate whether the implementation of labor market flexibility has produced the desired effects on employment as stated by the 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 the labor market regulation index in the MENA region from 2005 to 2019 as well as the two-stage D-GMM estimator method and the two-stage SYS-GMM method to evaluate the robustness of the results. We also examine the validity of the neoclassical hypothesis regarding the effect of flexibility on employment.
Findings and Discussion: Based on the results, labor market regulations have a positive and insignificant effect on youth employment, which does not provide evidence in support of 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 but, in the case of the population growth variable, the SYS-GMM estimator shows a significant negative effect.
Conclusions and policy implications: The economic literature suggests that higher labor market flexibility is one of the main pillars to increase youth employment. Indeed, a rigid labor market increases production costs for firms and reduces firms’ competitiveness in international markets; 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 regarding the effect of growth on youth employment. That economic growth allows for the increase of youth employment is not new because, over time, it has been confirmed empirically in several previous studies. Instead, much discussion revolves around the debate of how to create an environment which is 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 in this regard is to increase the flexibility of the labor market through a) the introduction of atypical jobs (fixed and part-time contracts) to facilitate the entry of young people into the labor market, b) lowering the hiring and firing costs, allowing firms to increase their competitiveness on international markets and adjust the labor demand according to the business, c) reducing employment security, aiming to reduce the protection that insider workers enjoy, thus preventing the labor market segmentation described by the insider-outsider theory, and d) 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 sectors. On the other hand, government hiring practices have typically placed a premium on diplomas over actual skills and contributed 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. This is 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-enhancing 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, reducing information asymmetry in job-search processes, and raising the average job-matching rate.

Keywords

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The Journal of Economic Policy
Volume 16, Issue 31
September 2024
Pages 232-276

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