Flexibility in Sri Lanka's labor market

w_Vs_ \ POLICY RESEARCH WORKING PAPER 1262 Flexibility in Sri Lanka's Not all labor regulations in Sri Lanka are distortive, but the Labor Market Terr.mination of Employment of Workmen Act does reduce Martin Rama firing and hiring. Repealing the Termination of Employment of Workmen Act would facilitate restructuring in the regulated sector and reduce the average spell of unemployment. The World Bank Policy Research Department Trade Policy Division March 1994  POLICY RESEARCH WORKING PAPER 1262 Summary findings Sri Lanka has had double-digit unemployment rates for activities arc greater than they should he, bccauise of more than a decade. And by 1990, 85 percent of the protection. Rama concludes that it is necessary to repcx unemployed had spent morE than a year searching for a the Termination of Ermplovmcnt of Workmen Act to job. Rama ana!yzes whether high unemployment rates avoid the massive destruction of jobs in those activities, and long spells of unemployment are the result of should foreign trade be further liberalized. Many firms profuse legislation of the labor market or of market the protected sectors would have to restructure and shut imperfections that would have prevailed even without down sorne of their product lines. By being prevcntted government intervention, from doing so, these firms rnight just go bankrupt, and He shows that not all of the labor market regulations many more jobs would be lost as a result. currently in force are highly distortive. Despite minimum Relaxing restrictions on retrenchment would wages set by wage boards, and despite collective unambiguously increase the turnover rate, says Rama. bargaining, real wages are neither too high nor too rigid. There would be both more hiring and more firing. The And despite the freedom of unions, labor relations are unemployment rate would increase in the short run bLut peaceful in the private sector. the average spell of unemployment would be shorter. A mismatch of skills is only marginally relevant, says This would help solve the explosive problem of Rama. Unemployment is better understood as the unemployed youths. outcome of job search in a significantly heterogeneous This conclusiorn does not apply to tea plantations, job market. given the few alternative sources of employment for thc It is worth remembering that Sri Lanka is a partially Indian Tamil workers and given ethnic obstacles to their closed economy, in which many import-competing labor mobility. This paper - a product of the irade Policy )ivision, Policy Research l)ep.artmcnt -- is part of a larger effort in the dLpartmilet to understand the impact of labor market policies and institutions on economiiic performiance. ( opics of thc paper are available free from the World Bank, 1818 H Street NW, Washinigton, 1D 2043 . Please contact Patricia Cook, room NS-057, cxtcinsio 33902 (28 pages). March 1994. The Policy Research Workirg Paper .5eries c.ssemninates the findings of woork in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are It ss than fully tpihsbed. 7The papers carry the names of the autbors and should be used and cited accordingly. The findings, interpretatisos, and conclusions are the authors' own and should not be attributed to the W orld Bank, its E.Ws1ctil e Board sof l)irectors, (J ny of its tne"nber ce