Flexibility in Sri Lanka's labor market

Sri Lanka has had double-digit unemployment rates for more than a decade. And by 1990, 85 percent of the unemployed had spent more than a year searching for a job. Rama analyzes whether high unemployment rates and long spells of unemployment are the result of profuse legislation of the labor market or of market imperfections that would have prevailed even without government intervention. He shows that not all of the labor market regulations currently in force are highly distortive. Despite minimum wages set by wage boards, and despite collective bargaining, real wages are neither too high nor too rigid. And despite the freedom of unions, labor relations are peaceful in the private sector. A mismatch of skills is only marginally relevant, says Rama. Unemployment is better understood as the outcome of job search in a significantly heterogenous job market. It is worth remembering that Sri Lanka is a partially closed economy, in which many import-competing activities are greater than they should be, because of protection. Rama concludes that it is necessary to repeal the Termination of Employment of Workmen Act to avoid the massive destruction of jobs in those activities, should foreign trade be further liberalized. Many firms in the protected sectors would have to restructure and shut down some of their product lines. By being prevented from doing so, these firms might just go bankrupt, and many more jobs would be lost as a result. Relaxing restrictions on retrenchment would unambiguously increase the turnover rate, says Rama. There would be both more hiring and more firing. The unemployment rate would increase in the short run but the average spell of unemployment would be shorter. This would help solve the explosive problem of unemployed youths. This conclusion does not apply to tea plantations, given the few alternative sources of employment for the Indian Tamil workers and given ethnic obstacles to their labor mobility.