Stricter labour laws go hand-in-hand with less enforcement effort

Ravi Kanbur, Lucas Ronconi

Current de jure measures of labour regulation stringency point to negative consequences of labour laws. This column presents new evidence on cross-country measurements of enforcement of labour laws from almost every country in the world. The authors argue that the consequences of labour enforcement cannot be credibly assessed using de jure measures which ignore the chance that enforcement is lower in places with stricter laws. On average, there is a negative correlation between the stringency of labour regulation and the intensity of its enforcement.

The causes and consequences of labour regulation have received substantial attention from economists and social scientists. Cross-country studies invariably use de jure measures of labour regulation stringency. This is true, for example, of the highly influential study by Botero et al. (2004), whose findings have been used to argue for the negative consequences of labour regulation.1 But how can we credibly assess the consequences of labour regulation if we only consider the letter of the law, ignoring the possibility that enforcement is lower in those places where the law is more stringent?

These are not purely hypothetical questions. Non-compliance with labour regulations is pervasive around the world.2 Furthermore, non-compliance is particularly high in developing countries, and at the same time those countries tend to have the most stringent regulations. Is it correct to assume that state intervention in the labour market is more stringent in Venezuela or Angola, where labour laws are quite protective but enforcement and compliance are very low, than in Canada or New Zealand where the opposite occurs? The existing cross-country empirical research, however, usually makes such an unrealistic assumption because of lack of data on enforcement.

Measuring enforcement effort

Our recent research develops, to our knowledge for the first time, data on resources devoted to enforcement of labour laws across almost every country in the world (Kanbur and Ronconi 2016). How do we set about doing this? Conceptually, the objective is to measure state actions to achieve compliance with labour regulations. State actions can be categorised into two groups. First are activities that affect the probability of finding employers who violate the law, and second are actions that determine the expected penalty. We attempt to develop quantitative measures along each of these dimensions.

There is no single source of information to measure labour inspection agencies’ resources and activities across most of the countries in the world. The relatively new ILOSTAT database, for example, only provides information about labour inspection for 53 countries. Therefore, we compiled data and statistics from governments’ websites, from reports produced by the International Labour organisation (ILO), the US Department of Labour, and the US State Department.

To count the number of inspectors we follow the definition suggested in ILOSTAT, according to which a labour inspector is a public official responsible for securing enforcement of the legal provisions relating to wages, safety and health, hours, the employment of children, and other connected matters. The second variable we construct is the number of labour inspections conducted per year. Both variables are normalised by the labour force in each country. The constructed variables cover 197 countries and territories in the case of inspectors and 131 in the case of inspections. Full details are available in Kanbur and Ronconi (2016). Table 1 presents the figures by region, excluding countries with a population below one million. Countries in Europe, the Middle East and North Africa present the highest values, and sub-Saharan Africa, Central and South Asia the lowest.

Table 1. Number of labour inspectors and inspections per worker by region

Notes: This table presents the simple average across countries of the number of labour inspectors per 100,000 workers, and the number of labour inspections conducted per year per million workers. Countries with a population below one million in 2011 are excluded. Figures are for the period 2000-2012.

The penalty structures for labour law violations are highly varied across countries and differ by type of regulation. Given the data sources, we focus on penalties for violations of regulations with wage provisions. Specifically, we construct a measure of penalties specified in the law in case of non-compliance with the minimum wage under a number of assumptions using the ILO TRAVAIL legal database, and country legislation.3 It covers 187 countries and their relevant penalties in 2011.

Penalties typically take the form of financial fines, either set as a monetary amount or as a proportion of the minimum wage. Some countries set a single fine, others set a minimum and a maximum, and yet others only set a maximum. But penalties can also include criminal fines. In almost one out of four countries around the world, the applicable legislation stipulates imprisonment.

We construct measures of de jure penalties for alternative scenarios. The medium total penalty scenario assumes a 50% probability of receiving a medium financial fine and a 25% probability of receiving the medium term in prison.4 We convert criminal penalties into a monetary metric by assuming that the cost for an employer of serving one year in prison equals ten times GDP per worker. Table 2 presents these measures by region. The simple average across countries for the medium financial fine equals $1,171 and for the medium prison term equals 0.19 years. Financial fines tend to be higher in more developed regions, and imprisonment varies substantially from basically zero in Europe to more than four months in sub-Saharan Africa, East Asia, and the Pacific.

Table 2. De jure penalties in case of minimum wage violation by region

Notes: The table presents the simple average across countries of de jure penalties in case of violation of the minimum wage in 2011. The medium financial fine is defined as the average between the minimum and the maximum fine and converted to US$ using the official exchange rate. The medium term in prison is the average between the minimum and the maximum terms and it is expressed in years.

Stringency of law and intensity of enforcement effort

Having developed cross-country measures of enforcement effort, we explore the relationship between de jure employment regulation and labour enforcement effort across countries. First, using the World Bank Doing Business database for the year 2011, and following a similar methodology as Botero et al. (2004), we create the employment law index.5 Second, we combine the inspection and penalties measures to construct enforcement indices.

A key stylised fact that emerges is that countries with more stringent employment regulations tend to enforce less. Figure 1 is a scatter plot that illustrates the negative correlation using rankings based on the above measures of de jure regulation and enforcement for one enforcement index. Countries with more stringent labour codes (i.e. with higher ranking positions based on the employment law index) tend to enforce less (i.e. lower ranking position based on the enforcement index).

Figure 1. The negative correlation across countries between enforcement and labour law

Notes: The horizontal axis is a ranking based on the de jure employment index wherein countries with more protective regulations have a higher ranking. The vertical axis is a ranking based on the enforcement index wherein countries with higher enforcement (labour inspectors and fines) have a higher ranking. The linear model between these variables equals Ranking Enforcement Index = 130.7 – 0.53*Ranking Employment Law Index.

This negative correlation between stringency of the law and resources devoted to its enforcement is confirmed through a range of sensitivity analyses in our paper.

Some implications

The negative correlation between the letter of the law and enforcement efforts has been generally unnoticed in the literature, but it raises a series of very important questions.

First, it raises the theoretical question of whether and in what sense it is rational for a government to introduce a regulation which is only partially enforced.

Basu et al. (2009) argue that it is not irrational for a government to choose not to enforce a law it has passed if enforcement is costly. Whether the stringency of the law and intensity of its enforcement would move together depends on a number of factors, including whether the government can credibly commit to an enforcement effort or whether it can ‘turn a blind eye’ after having announced string enforcement measures.

Second, explanations of regulatory stringency often turn to ‘legal origin’ theory (La Porta et al. 2008).

This theory predicts that civil law countries have more protective formal legal rules; and second, that those formal rules are enforced in both legal traditions but particularly so in civil law countries because of the higher dislike for unregulated market outcomes. Our analysis finds that on the one hand, former colonies of France, Spain, and the other continental Europe colonisers presently have more stringent de jure labour regulations than former British colonies, as the legal origin theory predicts and as confirmed by La Porta et al. (2008) and Botero et al. (2004). On the other hand, using our enforcement data we show that they enforce less. These results suggest, at the very least, that a more nuanced version of the legal origin theory is needed.

Third, it should be obvious that the consequences of labour regulation for labour market outcomes depend not just on the stringency of the law but also on enforcement effort.

In the absence of any enforcement effort, variations in the stringency of the law do not matter at all since the law simply does not bite. Further, if there is enforcement but enforcement effort decreases as stringency of law increases, a correlation between de jure stringency of law and labour market outcomes will need to be interpreted carefully. In fact, in our paper we run exactly the same regressions as Botero et al. (2004) on labour market outcomes and labour law stringency, but introducing an enforcement resources variable as well. We find that these influential results, which have been used to argue for the negative consequences of labour regulation that the results in Botero et al. (2004) imply, tend to disappear once we control for enforcement.

We are aware of course that our own data on enforcement effort have limitations. Nevertheless, we believe that our results stand as a strong caution to those who would use de jure measures of labour law and regulation in studies which in turn lead to strong policy conclusions on the impact of these laws. Future research should go beyond the letter of the law and focus on effective regulation. Enforcement matters.

References

Almeida, R, and P Carneiro (2012), “Enforcement of Labor Regulation and Informality,” American Economic Journal: Applied Economics 4(3): 64-89.

Ashenfelter, O, and R Smith (1979), “Compliance with the Minimum Wage Law,” Journal of Political Economy 87(2): 333–350.

Basu, A, N Chau and R Kanbur (2010), “Turning a Blind Eye: Costly Enforcement, Credible Commitment and Minimum Wage Laws,” Economic Journal 120(543): 244–69.

Besley, T and R Burgess (2004), “Can Labor Regulation Hinder Economic Performance? Evidence from India,” (with Robin Burgess), Quarterly Journal of Economics, 19(1), 91-134. February.

Bhorat, H, R Kanbur and N Mayet (2012), “Minimum Wage Violations in South Africa,” International Labour Review 151(3): 277-287.

Botero, J et al. (2004), “The Regulation of Labor,” Quarterly Journal of Economics 119(4): 1339–82.

Djankov, S, and R Ramalho (2009), “Employment Laws in Developing Countries,” Journal of Comparative Economics 37(1): 3-13.

Feldmann, H (2009), “The Unemployment Effects of Labor Regulation around the World,” Journal of Comparative Economics 37(1): 76–90.

Heckman, J and C Pages (eds) (2004), Law and Employment: Lessons from Latin America and the Caribbean. Chicago: University of Chicago Press.

Kanbur, R and L Ronconi (2016), “Enforcement Matters: The Effective Regulation of Labor,” CEPR Discussion Paper No. 11098.

La Porta, R, F López-de-Silanes and A Shleifer (2008), “Economic Consequences of Legal Origin,” Journal of Economic Literature 46: 285-332.

Pires, R (2008), “Promoting Sustainable Compliance: Styles of Labour Inspection and Compliance Outcomes in Brazil,” International Labour Review 147(2–3): 199-229.

Ronconi, L (2010), “Enforcement and Compliance with Labor Regulations in Argentina,” Industrial and Labor Relations Review 64(4): 719-36.

Endnotes

[1] For other studies in this vein, see Djankov and Ramalho (2009), Heckman and Pages (2004) and Feldmann (2009). The equally influential study by Besley and Burgess (2004) is for India, but for a cross section of Indian states.

[2] See, for example, Ashenfelter and Smith (1979), Almeida and Carneiro (2012), Bhorat et al. (2012), Pires (2008), and Ronconi (2010).

[3] We assume the following: i) the employer is a first-time offender; ii) the offense committed is paying one employee during one month a salary 20% below the legal minimum; iii) the employer does not obstruct the work of the inspector; iv) the employer corrects the problem after receiving a notice from the enforcement authority, and v) the employer does not retaliate against the employee. In countries with no minimum wage, we take the penalty that applies to violations of wage provisions. (Some countries set sectorial minimum wages through collective bargaining. In this case, we take the penalty that applies to violations of the minimum wage set in the collective agreement.)

[4] The medium financial fine is the average between the minimum and the maximum fine, and the medium term in prison is the average between the minimum and maximum terms.

[5] There are two main differences. First, we include the ratio of the minimum wage to the average value added of workers (also obtained from WBDB) as a component of the employment law index while Botero et al. (2004) do not. Second, Botero et al. (2004) computed not only an index of employment law, but also an index of collective relations law and an index of social security law.