Labor Market Reforms and Their Impact on Formal Labor Demand and Job Market Turnover: The Case of Peru

This paper analyzes the effects of several aspects of labor legislation that were modified through successive waves of reform since 1991. Firing costs diminished sharply through the progressive elimination of job security regulations, the introduction of temporary contracts and changes in the severance payment structure. Simultaneously, non-wage labor costs increased. To assess the effect of these changes on the level of formal employment, we estimate labor demand functions. We use a pseudo-panel data set for ten formal sectors observed bimonthly between 1987 and 1997 and panel data sets at the establishment level for three sub-periods. Both at the sector and establishment level, labor costs have a negative and significant effect on labor demand. The coefficient of our measure of firing costs, the expected severance payments, is negative and significant, and its magnitude decreases in the post reform period. After the reforms, the price and output elasticities are larger and there is evidence of a speedier labor demand adjustment. To assess the effect of regulations changes on turnover we use a series of repeated cross sections household surveys for Metropolitan Lima and calculate mean tenure using censored data. We find evidence that mean tenure fell since 1992. The fall is larger and more statistically significant for formal salaried workers than for informal workers. Using censored and complete employment spells from the Peruvian Living Standards Measurement Surveys we compare employment duration data for the formal and informal sectors using empirical hazards and parametric estimations of hazard functions. After the reforms, there is an increase in the hazard function for formal wage earners relative to the hazard function of informal sector wage earners. We find higher hazards for informal, private, temporary and blue-collar workers.