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Precarization or protection? How labour policies influence the effects of globalization on informality

by Lourenço S. Paz, Rita K. Almeida, Jennifer P. Poole

Globalization has generally coincided with a rise in work outside the formal economy, intensifying job precarization — when high-quality, formal jobs that entitle workers to benefits are replaced by jobs which may not comply with regulations and offer fewer benefits. In a recent study of the impacts of globalization on informality in Brazil, however, we find gains to formalization under certain circumstances. Globalization — as identified by a real exchange rate devaluation which made many exporting firms more competitive in global markets — increased formal sector employment during the 2000s. Meanwhile, the same real exchange rate shock protected smaller importing firms — those that typically employ informal workers — from foreign competition, thereby further improving rates of formality in the country.

But we also find that stricter enforcement of labour regulations prevents larger increases in formality from occurring. This finding should give those policy makers interested in formalizing the labour force in open, emerging economies, serious pause. Stricter enforcement of the labour code is a standard policy measure to increase formality; the fact that this policy option may attenuate the benefits of globalization, when economic conditions allow firms to grow and formalize, is a possibility that our work demonstrates requires closer consideration.

We use municipality- and industry-level data on worker formality and labour inspections in Brazil to uncover the effects of labour regulatory enforcement on changes in formal employment shares over time. For import-competing firms, we estimate that a 1% depreciation in the import-weighted real exchange rate increases formality by 0.6 percentage points. For exporters, we estimate that a 1% depreciation in the export-weighted real exchange rate reduces informality by 0.2 percentage points, increases formality by 0.4 percentage points, and decreases the share of self-employed workers among higher-tier formal jobs by 0.3 percentage points.

However, the increases in formal employment are weaker in municipalities with greater enforcement of labour regulations. It appears that enforcement can act as ‘sand in the wheels’ of trade-related employment growth. These findings shed light on the link between enforcement of labour regulations and the effects of globalization on job precarization.

The case of Brazil

In the 2000s, informality in Brazil fell from around 20% to 13% of the workforce, while the share of self-employed workers remained steady. The formal economy then increased from 63% to 71% of workers. The country also underwent a dramatic trade liberalization during the 1990s and suffered a currency devaluation in 1999. 

Globalization may magnify or attenuate job precarization. On the one hand, globalization enhances export opportunities. Since exporting is conducted by larger firms that offer formal employment, access to foreign markets can improve levels of formalization. But globalization also promotes imports, which increases competition. As a result, the smallest firms may exit the market while others may switch from formal to self-employed or informal workers. Thus, in theory, the effect of globalization on job precarization is ambiguous and, so far, the evidence in the literature is mixed.

An exchange rate depreciation reduces import competition by increasing the relative price of foreign goods in local currency terms. This decrease in competition allows firms to expand output, increasing formality, particularly for smaller, lower-productivity, import-competing firms which tend to employ informal workers. In fact, our empirical exercise confirms this hypothesis. A 1% depreciation in the import-weighted real exchange rate increases formality by 0.6 percentage points.

The same depreciation also decreases the prices of Brazilian goods in foreign markets, thus expanding access for Brazilian exporters, typically the more productive firms, employing formal workers. In theory, the exchange rate shock should further increase formality, in part by formalizing the self-employed. Our estimates are in line with these predictions. A 1% depreciation in the export-weighted real exchange rate reduces informality by 0.2 percentage points, increases formality by 0.4 percentage points, and decreases the share of self-employed workers among higher-tier formal jobs by 0.3 percentage points.

The role of labour regulations and levels of enforcement

Employment is formal if it complies with all labour regulations, which establish benefits like paid annual leave, maternity leave, and severance. If the employer does not comply with regulations, the employment is considered informal. De jure regulations — those set out in the legal code — establish how rigid or flexible are labour markets. The size of the informal economy therefore suggests to some extent the scale of the gap between de jure and de facto regulations — those actually followed by workers and employers. One reason for this divide is the inability of regulators to completely enforce the laws on the books.

An increase in enforcement should reduce informality by bringing de facto regulations closer in line with de jure regulations. Then again, stricter enforcement also raises the cost of formal workers. As such, plants facing stricter enforcement of the labour code may have increased difficulties in adjusting their labour force to changing economic conditions, ultimately decreasing formality.

As informal workers are ‘off the books’, tax evasion by the employer and by the worker is common and, therefore, these types of arrangements are illegal in many settings. Self-employment is therefore the cheapest legal alternative to formality. Since the cost to employers of self-employed workers is less than the cost of employing formal workers, firms in strictly-enforced areas would increase hiring of self-employed workers to circumvent labour regulations legally.

For Brazil, during a period of formal employment expansion, labour enforcement did appear to act as ‘sand in the wheels’ of this economic growth, mitigating job-quality improvements associated with the real exchange rate depreciation. That is, the increases in the formal economy were weaker in more strictly-enforced municipalities. The shifts out of self-employment into formal employment were also moderated. This case speaks to the public policy debate on the trade-off between economic growth and job security. That rigid labour policy may amplify the income inequality effects of globalization, pushing workers into more precarious jobs, should give policy makers serious pause.

The views expressed in this piece are those of the author(s), and do not necessarily reflect the views of the Institute or the United Nations University, nor the programme/project donors.

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Over 2 billion workers globally are informal — what should we do about it?
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