The Impact of Labor Market Regulations

40 Pages Posted: 20 Apr 2016

See all articles by Lyn Squire

Lyn Squire

Global Development Network

Sethaput Suthiwart-Narueput

World Bank - Public Economics Division; Sasin GIBA

Date Written: February 1995


There may be natural limits on the efficiency losses engendered by labor market regulations, although such costs could be significant in some countries at some times.

Squire and Suthiwart-Narueput investigate the impact of labor market regulations in settings where compliance is incomplete. They review some stylized facts about labor market behavior, present an analytical model that may explain such behavior, and provide a checklist for assessing the distortionary impact of a regulation such as the minimum wage.

They take as their starting point the limited evidence about the distortionary effects of such regulations and argue that there may be natural limits on the efficiency losses engendered by labor market regulations.

First, the regulations may not be binding at market equilibrium. For example, minimum wages may be set so low that they are ineffective. Second, even if they are binding, the relevant elasticities of supply and demand may be so low that the regulations have little impact on efficiency.

Third, even if the regulations are binding and elasticities are sizable, compliance may be low.

Squire and Suthiwart-Narueput argue that the likelihood of compliance will be greatest when the regulations are binding and the relevant elasticities are sizable. That is, if the distortionary costs of regulations are not rendered insignificant by the first two reasons, then the returns to noncompliance will be high and, other things being equal, employers will evade or avoid the regulations, thereby minimizing the impact on efficiency.

The argument rests on profit maximization subject to a hard budget constraint. Public enterprises, which are not concerned only with profit maximization and often have softer budget constraints than the private sector, may be more willing to conform to profit-reducing regulations, but in this case the authors argue that compliance may reduce already-existing efficiency losses.

This paper - a joint product of the Office of the Director and the Public Economics Division, Policy Research Department - is one in a series of background papers prepared for the World Development Report 1995 on labor.

Suggested Citation

Squire, Lyn and Suthiwart-Narueput, Sethaput, The Impact of Labor Market Regulations (February 1995). World Bank Policy Research Working Paper No. 1418. Available at SSRN:

Lyn Squire

Global Development Network ( email )

2600 Virginia Avenue, NW
Suite 1112
Washington, DC 20037
United States

Sethaput Suthiwart-Narueput (Contact Author)

World Bank - Public Economics Division ( email )

1818 H Street
Washington, DC 20433
United States
202-473 4604 (Phone)
202-522 1154 (Fax)

Sasin GIBA

Bangkok 10330

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