Aggregate: Stronger macroeconomic stabilizers

82 e mployment in Crisis

job was formal or informal, these programs lessen the extent to which labor market adjustment translates into short- and longterm impacts on workers (as illustrated by the top arrow of figure 4.1).

The labor scarring documented in this study and its adverse impact on countries’ potential productivity imply that the LAC region could achieve greater long-term growth if crisis-induced, worker-level human capital decay was reduced. This change would require cushioning the short-term impact of crises through both short-term income support to protect welfare and social protection and labor policies to build human capital and promote faster, higher-quality transitions for displaced workers moving into new jobs. The speed and extent of scarring in the region require that social protection and labor systems provide more than just income support. They should also help people to renew and redeploy their human capital. It is in this broader sense that reforms to the region’s existing social protection and labor policies and systems are urgently needed. These transformations will, in turn, affect labor market flows and provide a responsive safety net that contributes meaningfully and effectively to countries’ automatic stabilizers, as detailed below.

Although social protection and labor programs cushion workers from the impacts of crises, they do not address the structural issues that determine the magnitude of these impacts in the first place. For example, this report highlights the dichotomy between protected and unprotected firms in the LAC region (caused by the lack of contestability and competition, high levels of concentration, and market power held by the former group of firms) and the sluggish mobility of labor across economically lagging and leading localities, both of which serve to magnify the welfare effects of shocks. This study also highlights pockets of labor market rigidity that are slowing transitions between jobs. Hence, competition policies, regional policies, and labor market regulations are a third key policy dimension determining the effects of crises (as illustrated by the bottom arrow in figure 4.1). These structural issues may also be behind LAC labor markets’ poor adjustment to crises, and they might require interventions at the sector and locality levels, in addition to worker-level and economy-wide interventions, and that interact with social protection needs and incentives (as illustrated by the vertical arrows in figure 4.1). LAC countries’ policy responses need to tackle these structural issues squarely, according to the weights they hold in each country or setting.

As illustrated in figure 4.1, the first shield against a crisis is the strength of a country’s macroeconomic frameworks and automatic stabilizers. These policies filter the extent to which an exogenous shock affects the domestic labor market and, especially relevant to Latin America and the Caribbean, the extent to which domestic conditions can lead to a crisis situation. This section looks at how the LAC region has improved in terms of its macroeconomic frameworks, leading to fewer domestic crises, although it still lacks sufficient automatic stabilizers.

Stronger macroeconomic frameworks

Few would disagree that avoiding crises in the first place is an important priority to limit their effects, which occur at both the aggregate and the individual levels. As documented in this study, the LAC region experiences frequent crises. During one-third of the quarters between 1980 and 2018, one or more countries in the region was in an economic crisis (as mentioned in chapter 1). However, prudent fiscal and monetary policies can lower the likelihood of certain types of crises, and macroeconomic policies, including demand stimulus interventions and exchange rate depreciations, provide a first line of response to them. In recent decades, the LAC countries have made important strides in strengthening their macroeconomic frameworks and improving their governance and institutions.

t ow A rd A n i ntegr A ted p oli C y r esponse 83

These efforts have reduced the frequency of crises in the region, especially those of domestic origin. However, some crises persist, most notably the crisis in the República Bolivariana de Venezuela but also recent political or economic crises in Argentina, Brazil, Haiti, and Nicaragua.

In a critical point to understanding how crises impact workers, the region’s stronger macroeconomic frameworks have also altered the nature of the region’s labor market adjustments. Because of these stronger frameworks, crises in the LAC region now occur in the context of relatively low inflation. In contrast, the 1980s and early 1990s were characterized by high inflation in most countries in the region. Latin American monetary policies in the 1990s and early 2000s were increasingly aimed at keeping inflation low (Céspedes, Chang, and Velasco 2014). For example, following the Tequila Crisis, Mexico moved from a fixed exchange rate policy to a floating exchange rate policy and instituted relatively strict inflation-targeting rules. Since the early 2000s, most countries in the region have succeeded in taming inflation. The unweighted average inflation rate in the region was 69.6 percent in the 1980s and 30.0 percent in the 1990s, but it fell to only 5.4 percent in the 2000s.3

Although this new macroeconomic context has reduced the number of domestic crises in the LAC region, it also has implications for how the region’s labor markets adjust to the crises that do occur. Low inflation reduces the downward flexibility of real wages, while firms’ ability to cut the nominal wages of existing workers is limited by contracts (formal and informal agreements) and by labor legislation, such as binding statutory minimum wages that are set high relative to average earnings.4 Hence, firms operating in contexts where inflation is low and stable cannot rely on inflation to help erode real wages during a crisis. Rather, firms can reduce their labor costs only through quantitative adjustments, such as reducing their numbers of positions. As a result, the reduction in inflation likely increased the extent to which labor markets adjust to crises along the quantitative margin (employment). In a recent paper, Gambetti and Messina (2018) show that real wage flexibility declined in Brazil, Chile, Colombia, and Mexico from 1980 to 2010. This result is in line with previous research that has found evidence of falling real wage flexibility in LAC countries over this period (see Lederman, Maloney, and Messina [2011] for the region as a whole, Messina and Sanz-de-Galdeano [2014] for Brazil and Uruguay, and Casarín and Juárez [2015] for Mexico).

The resulting changes in LAC labor markets’ adjustment to economic shocks can be illustrated by the differences in responses to crises in Brazil and Mexico during the 1990s versus during the 2000s. The panels in figure 4.2 track fluctuations in the real log gross domestic product (GDP), the inflation rate, mean real wages, and the unemployment rate before and after the first quarter of negative growth (identified as t = 0 in the graphs) for four crises: the 1994 Tequila Crisis and the 2008–09 global financial crisis in Mexico and the 1990 and 2015 recessions in Brazil. The figure shows that inflation increased significantly during the Tequila Crisis in Mexico, whereas it remained flat during the 2008–09 downturn. Similarly, in Brazil, the recession of 1990 was characterized by a spike in inflation, whereas inflation remained flat in the more recent crisis.

Given the region’s lower inflation rates during more recent crises, one would expect that real wages have not adjusted as much in these crises as in earlier crises. As shown in figure 4.2, real wages fell more significantly during the earlier crises in both Brazil and Mexico. This difference suggests that the price margin is becoming less central to labor market adjustments. These findings are confirmed in Robertson (2020).

If real wage adjustment was an important margin of labor market adjustment during earlier growth shocks, then, given the current context of lower inflation rates, quantitative adjustment has likely taken on increased importance, as the cases of Brazil