Greater labour market flexibility will reduce unemployment

SA’s high unemployment rates have been a regular fixture on the economy’s track record since at least the mid 1970’s and although the situation has improved somewhat recently, thanks in large part to economic growth, the rate of unemployment is still unacceptably high. The large numbers of people that simply loiter on street corners and mill around construction sites, the majority of whom are young and in the prime working-age group, are visible evidence of this unfortunate situation.

According to the latest labour force survey (LFS), approximately 4,336 million working aged adults were officially unemployed. This equates to an official unemployment rate of 25.5 per cent. However, a further 3,503 million did not actively search for work in the month prior to the survey, but indicated they would work if jobs were available. If we include these discouraged work seekers the total number of unemployed increases to 7,839 million and the unemployment rate shoots to the more realistic rate of 38.3 per cent. Approximately three-quarters of the unemployed are younger than 34 years, and if we focus exclusively on the 15 to 24 age group, we find that over half of all youth are unemployed (50.2 per cent).

The cause of large-scale unemployment, according to neoclassical economics, is that wages are set above the market clearing level. In other words, high labour costs resulting in many cases from minimum wage laws, reduce the employment opportunities of unemployed people with few skills who would otherwise typically find employment in small and micro enterprises. The latest Economic Freedom of the World (EFW) report, which is a comparative study of the economies of nations, supports this assertion.

The report measures the degree to which the policies and institutions of the 141 countries surveyed are supportive of economic freedom. The foundations of economic freedom are personal choice, voluntary exchange, freedom to compete and security of privately owned property. Forty-two data points are used to construct a summary index and to measure the degree of economic freedom in five broad areas: size of government; legal structure and security of property rights; access to sound money; freedom to trade internationally; and regulation of credit, labour and business.

According to the latest report SA slid from 54th to 60th in the country rankings. This slide is not indicative of a decline in economic freedom, but rather the relative improvement of other countries reforming faster than SA. However, one of the areas in which SA does fall short, is that of labour market freedoms. SA’s score was particularly low in the area of minimum wages, at 3.4 out of 10. SA also scored dismally in the area of hiring and firing regulations, scoring 2.4 out of 10.

According to the World Bank, SA has a relatively inflexible labour market. In its Doing Business report SA received a rating of 56 out of 100 (with higher ratings indicating more rigid regulations). Compare this with the sub-Saharan African region as a whole, which received 41.7 out of 100 and the OECD average of 25.2 out of 100. In the area of rigidity of employment laws and regulations SA with a rating of 42 scored well above the world average of 32.2 and roughly equalled the sub-Saharan average of 42.6.

South African labour laws provide people who are employed with a high degree of security at the expense of the unemployed. Labour union representatives argue that any weakening of job-security legislation and erosion of minimum wages will lead to increased poverty. But unemployment is a significant driver of poverty and inequality.

The unemployed are prevented from gaining work experience while their productivity is not high enough to justify the wages that the law compels employers to pay them. Over time, the employability of an unemployed person deteriorates even further. Having been made unemployable by the combination of minimum wages and the costs to employers of complying with the labour laws, the unemployed find themselves in the unenviable situation where forced idleness further erodes their human capital value.

Regulators appear to be oblivious to the harm suffered by the individuals, most of them young, who are forced into idleness. Faced with an impervious labour market, which prevents them from working for below statutory minimum wages, that would enable them to maintain and increase their human capital, their remaining alternatives are bleak. Unfortunately, many of them turn to crime and prostitution in order to sustain themselves.

The artificial constraints on the functioning of SA’s labour market must be removed in order to alleviate the current chronic unemployment problem and reduce the harm that is being caused by enforced idleness. Removal of the constraints will rapidly reduce unemployment, restore the dignity and self-worth of the affected individuals, substantially increase small business development, and accelerate economic growth.

Author: Jasson Urbach is an economist with the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Foundation.

FMF Feature Article/ 09 October 2007