Labour Market Distortions in Sri Lanka: Have they reduced under liberalised economic policies?

Abstract

Studies such as Gupta (1989), Agarwala I 1983), and Little (1982), highlight that capital-Iabour ratios (technologies) are in fact sensitive to the relative cost of labour and capital. In this background, if the factor markets are distorted in favour of selecting capital intensive technologies, labour demand or the growth of employment is impeded. Agarwala’s (1983) study on ‘Price Distortion and Growth’ of 31 developing countries confirmed that as in the case of most of the developing countries Sri Lanka’s labour market was also highly distorted during the controlled era of the 1960s and the1970. Thus, those who highly emphasise labour market distortions promote exceedingly the case for economic reforms and labour market deregulation for developing countries to enhance their labour market ‘flexibility’ to bring about a positive effect on economic growth and speeding up of employment creation. Hence, in a background of implementing economic reforms with some changes in labour practices for more than two decades from 1 977 i n Sri Lanka, it requires to determine how far the cost of labour market distortions has decreased during the economic reform period. However, a debate over the cost of labour market distortions even after the economic reforms has emerged. Some are of the opinion that although the economy moved towards a free market following the 1977 economic policy changes the Sri Lankan labour market has not been reformed to be matched with the requirements of the open economy and remained distorted, imposing a higher labour cost to investors while others believe that Sri Lankan labour is more cheaper than most of the countries in the region. Meanwhile, starting from 2002, four key Acts on labour regulations such as the Factory Ordinance of 1942 (FO), the Termination of Employment of Workmen Act of 1971 (TEWA), The Industrial Dispute Act (IDA) of 1950 were amended with a view to increasing the labour market flexibility. In this setting, this paper aims at assessing how far Sri Lanka’s labour market distortions have reduced under the reform period mainly by comparing the Sri Lankan labour market regulations and behaviour with those of the neighbouring and some of the fast developing East Asian countries depending on the data availability for the period after 1977. This comparison is made on 1) minimum wage levels, 2) employment security legislations, 3) holidays and leave, 4) maternity benefits, and 5) industrial relations.Evidence gathered shows that contrary to the conventional wisdom the minimum wage regulations in Sri Lanka do not have a large positive impact on increasing employers’ costs of labour. But quite the opposite impact on the costs of labour could be seen arising from the regulations related to the employment security, contributions to social security programmes, and the private sector and the public sector holiday and leave. These regulations have a consider ably high positive effect on increasing employers’ non-wage labour costs in Sri Lanka. Also, 13 new major labour regulations relating to various aspects of working life have been enacted after 1977 and the cost of social security has increased during the reform period. Moreover, it has been found that more than anything else the highly deteriorated industrial relations system has damaged labour market flexibility in Sri Lanka and thereby imposed a huge cost to employers without showing any improvement of labour relations from the controlled era to be consistent with open economic policy regime. Consequently, the paper concludes that more than the other countries in the region the costs of labour market distortions in Sri Lanka have significantly increased during the reform period after 19771 resulting in a considerable retardation in the labour market demand .