Places: The role of local opportunities and informality

68 e mployment in Crisis

evaluate changes in worker-level employment and wages according to the type of market structure and the type of firm. The results are presented in figure 3.8. They show, for example, that workers who at the time of the crisis work in markets with low market concentration incur larger scarring effects. In these less concentrated sectors, lower wages and lower employment are seen in response to shocks, as economic theory predicts. Conversely, in sectors in which a few firms control a large share of the market, a negative demand shock does not result in employment losses—rather, it increases employment—and wages do not adjust. These results are consistent with the idea that firms with more market power are more protected from negative shocks. Although the workers in these sectors are better insulated from crises than other workers, the costs of this protection are borne by the economy as a whole.

The existence of imperfect competition in output markets is well accepted by economists (as asserted by Card et al. 2018), and concerns about imperfect competition in Latin American product markets have emerged in policy discussions (OECD 2015). These policy discussions hinge critically on the source of the concentration in these product markets. There are several potential sources, including economic barriers to entry (such as large fixed costs), political barriers to entry (such as government protections or regulation), and firm-level productivity differences that result in the most productive firms driving out less productive firms (Melitz 2003).

Recent work suggests that firm rents are prevalent in developing countries and that they are frequently associated with political connections, both in Latin America (Brugués, Brugués, and Giambra 2018) and elsewhere (Rijkers, Freund, and Nucifora 2017). State-owned firms are an extreme example of firms with strong political connections. These firms are less profitable in general and have higher labor-to-capital ratios than private firms (Dewenter and Malatesta 2001). Although a large literature describes the differences in employment choices between state-owned and private firms, little empirical evidence compares the differences in employment adjustment to shocks between state-protected firms and unprotected firms.

To fill this gap, Fernandes and Silva (2021) compare the change in employment following a negative shock in state-owned firms and in private firms. They find that state-owned firms adjusted less along the intensive margin (workers’ months worked) in response to the global financial crisis of 2008–09 because these firms were shielded from the shock.

So far, this chapter has explored the potential differences in scarring caused by differences in personal (demographic) characteristics and firm characteristics. A third dimension that could affect labor market scarring is the properties of the local labor markets in which workers live and work. Recent research has paid increasing attention to the significant costs workers bear when moving between cities or industries. Dix-Carneiro (2014) estimates that the median direct mobility cost that workers face when switching sectors ranges from 1.4 to 2.7 times the average annual wage. Artuc, Chaudhuri, and McLaren (2010) and Artuc and McLaren (2015) obtain similar estimates for the cost of changing sectors. The costs of changing locations, by some estimates, can be as high as 7 times the average annual income (Bayer, Keohane, and Timmins 2009; Bishop 2008; Kennan and Walker 2011).3 As a result, workers, especially low-wage workers, tend to be more closely tied to their local labor markets than was previously thought.

Such ties to local labor markets means that the characteristics of those markets might play a significant role in shaping labor market scarring. For example, Meekes and Hassink (2019) show that the local housing market significantly affects workers following job losses—the effect of displacement on their probability of changing homes is negative. Lessons from the previous section already suggest that the amount of concentration in

t he i mp AC t on w orkers, Firms, A nd p l AC es 69

an industry might affect employment and wages. Living in a “company town” offers very different opportunities than does living in a large and diversified metropolitan area. The degree of informality in the local labor market also matters.

Informality might affect scarring in several important ways, and not all of them point in the same direction. For many workers, especially in the LAC region, the informal labor market is considered to be a safety net that replaces the traditional role of social insurance. Workers who lose formal sector jobs and find themselves without family or government support have little choice but to accept any available job opportunity. When the legal requirements for starting or operating a business are not strictly enforced, these workers may have an easier time setting up informal businesses (such as the street market shops, or tianguis, often seen in Mexico) than regaining formal employment. Informal sector employment can therefore offer opportunities for human capital accumulation through experience and entrepreneurship.

However, the presence of a large informal sector may indicate imperfect enforcement of the minimum wage or other employment laws. In many cases, informal sector entrepreneurs offer services to exporting firms and formal sector firms that help those firms smooth out demand fluctuations. Because of the various firm-level costs to adjust employment, formal sector firms prefer to keep relatively constant formal labor forces. In some cases, employment laws even motivate firms to hire fewer workers during peak times than they otherwise would. Instead, when demand increases, exporting formal sector firms subcontract with informal firms or hire workers informally to meet the surge in demand. When demand contracts, the formal sector firms simply reduce their orders and employment for the informal sector or reduce their use of informal workers, keeping their formal employment more or less constant. Therefore, formal workers in areas with high informality may find wage growth elusive, because the essentially infinite supply of informal workers available to perform unfilled jobs weakens the link between increased labor demand and the need for their firms to raise wages. This effect generates results similar to those of labor market scarring—but, on the other hand, job losses in the formal sector might be lower in these localities than in those with less informality.

Recent work for this study sheds light on this apparent contradiction in several ways. First, Fernandes and Silva (2021) find that formal workers in municipalities with higher levels of informality lost less in the global financial crisis. In particular, within a given country, the paper finds smaller employment and wage losses for formal workers hit by shocks who live in less formal local labor markets, suggesting that the medium-run effects of crises on unemployment are lower for formal workers in places where informality is higher. Ironically, the effects of crises may even shift from negative to positive for workers in municipalities with high informality rates. These results are consistent with the idea that (a) in the presence of informality, formal firms may employ informal workers and (b) those firms reduce their employment of informal workers, rather than formal workers, in the face of negative export shocks (figure 3.9). In this context, informality may provide de facto flexibility for firms and workers to cope with adverse shocks. This result is in line with findings on the effect of trade liberalization in Brazil by Dix-Carneiro and Kovak (2019) and Ponczek and Ulyssea (2018).

This study also finds that workers in localities with more (alternative) job opportunities bounce back better from crises. Specifically, larger and longer-lasting losses in employment (and sometimes wages) in response to a crisis are found for formal workers in localities with larger primary sectors, smaller service sectors, fewer large firms, and production highly concentrated in the same sector where they were employed precrisis (Fernandes and Silva 2021). These workers’ persistent earnings losses may reflect their lack of opportunities in the rebound, not just “scarring” in the traditional sense of a persistent loss of human capital associated with a period of unemployment or lower-quality employment.