Introduction

Toward an Integrated Policy Response 4

Introduction

Few doubt that a better policy framework to mitigate, manage, and help people recover from crises is crucial for countries in Latin America and the Caribbean (LAC) to succeed in lifting their long-term growth rates and increasing their people’s well-being. Macroeconomic frameworks across the countries in the region changed dramatically in the 1990s, as did social protection and labor policies in the early 2000s. But changes in policy have been relatively limited since then. The COVID-19 pandemic and the associated sluggishness of the global economy may be prolonged, and structural changes in labor markets are ongoing. Given these circumstances, crisis response has moved to the forefront of policy debate in the LAC region.

Considering the evidence presented in earlier chapters on the importance of demand to crisis adjustment and the triangle of workers, sectors and firms, and locations, how can policies mitigate the impacts of crises on workers and promote better recovery? This study shows that crises have a meaningful negative effect on welfare in the LAC region and that the documented labor market scarring is likely to affect the region’s economic growth potential. To mitigate this damage, policy makers should design and deploy instruments that cushion the effects of crises on workers in the short run; shock impacts spread unequally across workers and firms, and many will not regain their lost job, wages, or clients. But policy makers should pay just as much attention to efficiency and resilience, promoting peoples’ ability to bounce back when exposed to an adverse shock (which can be aided by healthy economic growth).

This chapter builds on the findings from the first three chapters to identify the necessary elements of an effective policy response to crises in Latin America and the Caribbean as revealed by these broader lenses. It discusses the policy implications of the previous chapters’ findings, assesses the ability of existing systems to tackle the challenges of crisis response, and discusses potential reforms, although it does not evaluate the impacts of the different policy responses proposed. The reported policy results and implementation details are based on the existing literature, and the new evidence presented on the effectiveness of reforms is based on past crises in the region.

78 e mployment in Crisis

The evidence featured in the previous chapters suggests that the success of policy responses to the crisis triggered by the COVID-19 pandemic will depend on whether response measures effectively prevent unnecessary destruction of human capital and otherwise viable enterprises and on the quality of complementary domestic policies and reforms beyond the labor market. Cushioning the crisis’s short-term impact through macroeconomic and social protection and labor policies will be crucial to avoiding poverty and excessive job destruction, given the employment and wage losses documented in this report. Strong, prudent macroeconomic frameworks and automatic stabilizers are the first line of defense to shield labor markets from crises. Prudent fiscal and monetary policies can lower the likelihood and severity of certain types of crises and provide the fiscal space needed to give support and avert system-wide financial strain when crises do occur.

In addition to macroeconomic policies, the typical automatic stabilizer used in Organisation for Economic Co-operation and Development (OECD) countries is reliable unemployment insurance, which many LAC countries still lack. This type of social protection and labor program is key to cushioning the impacts of crises on formal workers. However, many workers in the LAC region earn their living in the informal economy, and the best way to protect their consumption is through responsive cash transfer programs. Targeted on the basis of household need rather than whether the lost job was formal or informal, these programs reduce the extent to which labor market adjustment translates into short- and longterm impacts on the poor and vulnerable. Because reemployment is crucial to avoid scarring, active labor market programs to support reskilling and job search are a third vital element of effective social protection and labor systems.

Although social protection and labor systems can cushion workers from the impacts of crises, they do not address the structural issues that determine the magnitude of these impacts or the economy’s ability to bounce back. This study highlights, for example, the dichotomy between protected and unprotected firms in the LAC region (caused by the former group’s market power) and the region’s low geographic mobility of workers, both of which magnify the welfare effects of shocks. It also highlights pockets of rigidity in labor regulations that are slowing transitions of workers across jobs. Hence, competition policies, regional policies, and labor regulations are a third key dimension of a policy response to crises. These important structural issues are also causing LAC labor markets’ poor adjustment to crises, and might require interventions at the sector and locality levels that interact with social protection needs and incentives.

Local labor markets’ characteristics and sector product markets’ conditions determine the magnitude of the impacts of crises on workers. In terms of labor market regulations and institutions, this study documents limited adjustment through reductions in hours, more adjustment through unemployment, and an informal sector that serves as a buffer in some countries. With respect to product market conditions, the study finds that initially similar workers experience different employment and earnings outcomes after exposure to the same crisis because of differences in their sectors’ competition structures. It also documents that the localities where workers live affect the impacts they face. Its results suggest that employment and wage losses following shocks are smaller for formal workers who live in areas with more informality. Why do crisis effects pass through to workers more in some places than in others? One factor is that the geographic mobility of workers is lower than expected by economists and policy makers. Constraints on movement create friction in the stylized labor market adjustment mechanisms that can magnify welfare losses, as shown in earlier chapters. The policy response to crises needs to tackle these structural issues squarely, according to the weight each issue has in each country or setting.

t ow A rd A n i ntegr A ted p oli C y r esponse 79

Given the complexity of labor markets’ adjustment to economic crises in the LAC region, this report argues that countries can improve their responses by advancing on three fronts. The combination of policies needed is truly cross-sectorial, including macroeconomic, social protection and labor, competition, and regional policies, and it will determine the speed of adjustment and the trajectory of workers’ recoveries.

This chapter starts with a discussion of the public policy “shield” that determines how a crisis affects workers and their families— the country’s macroeconomic frameworks and automatic stabilizers. Strong, sound macroeconomic policies can decrease the frequency of crises, for example, by protecting against fiscal imbalances and domestic inflationary pressures. They can also lessen the severity of crises by reducing the size of the needed adjustments and shaping the adjustments’ composition. The LAC region has significantly improved its macroeconomic frameworks in the past few decades, resulting in fewer domestic crises and significantly lower inflation rates. Even so, its fiscal policy in particular remains weak and, in many countries, unsustainable, with small tax bases and relatively generous entitlement programs. Many countries in the region also lack social protection and labor programs that provide adequate automatic stabilizers (such as unemployment insurance).

The chapter next turns to the question of how governments can use labor markets and social protection policies to alleviate or revert the impacts of crises on workers and the economy. To begin answering this question, the chapter considers why most people in the LAC region are not covered by any formal income assistance for unemployment. It assesses the region’s existing income support programs (including unemployment insurance plans, cash transfers, and other social assistance benefits), their unintended (positive and negative) consequences as currently designed, and how they could be reengineered to provide a more effective crisis response. The chapter’s discussion of social protection and labor systems concludes by highlighting policy options that governments in the region could consider in order to improve the mixed record of their employment support programs and to reduce the (short- and long-term) impacts of crises on workers. A distinction is made between short-term, transitory programs enacted during crises to avoid excessive job losses (including employment retention schemes, temporary employment programs, and demand stimulus programs) and longer-term programs deployed by governments to reskill workers and ease their transitions between jobs. The latter set of programs are discussed in light of the LAC region’s mixed track record at reducing the duration of unemployment and improving the quality of job matches. Because even brief crises can leave lasting scars on workers, the formidable challenge for governments is to distinguish the crises requiring only transitory responses from those requiring more sustained support and to respond accordingly as workers and the economy adjust. This chapter also discusses insights from the existing evidence and policy experiences and recommends ways to improve the region’s responses to the current COVID-19 crisis.

Next, the chapter shifts its focus to the efficiency effects of crises and how to tackle structural issues that can worsen labor market adjustment—in particular, how to break rigidities, address the insider story, and respond to the lack of opportunities in some places and regions. Chapter 3 showed how factors beyond the labor market affect the magnitude of crises’ impacts on workers. Structural challenges in the LAC region act to slow and even prevent necessary labor market adjustments, hence weakening economic recoveries. These structural issues can change the nature—and the impact on people—of systemic shocks from transitory to long-term. The policy implication of these findings and the related literature is that even if a country’s macroeconomic policies and its social protection and labor system are in pristine order, the best outcomes for workers in the wake of crises can be achieved by complementing these measures with sectoral and place-based policies to deal with the structural issues