Costs reduce formal jobs and push people into the informal sector

South Africa has experienced high and rising rates of unemployment since the mid-1970s and we probably now have one of the highest unemployment rates in the world. Statistics SA’s most recent Labour Force Survey (LFS) estimates that approximately 26 per cent (4.1 million) of the potential workforce is unemployed. If we include the individuals that have given up looking for work this figure rises to 42 per cent (8.0 million). Other middle-income developing countries such as Argentina and Brazil have strict unemployment rates of approximately 16.3 per cent and 12.2 per cent respectively. Contrast these rates with lower unemployment countries such as El Salvador (6.2%), Chile (7.8%), Costa Rica (6.4%) and Belgium (6.9%).

The September LFS told us that there were approximately 7.7 million individuals employed in the formal sector and 2.0 million employed in the informal sector (excluding agriculture). However, from March to September 2004 the number employed in the informal sector grew by about 10 per cent whereas formal sector employment grew by a meagre 2 per cent. The World Bank now estimates that the informal sector accounts for 28.4 per cent of SA’s gross national income. The September data also suggests that for the country as a whole, non-agricultural employment in the informal sector accounted for approximately 19 per cent of total employment. If domestic workers are included the percentage rises to 27 per cent. But why has employment remained relatively stagnant in the formal sector, while growing in the informal sector?

A recent study conducted by the World Bank analysed the barriers to doing business within an economy. The study compared the results found in SA with the average from countries within the OECD (Organisation for Co-operation and Development). Starting a business in South Africa requires an average of 9 procedures compared to 6 in OECD countries. As a result it takes an average of 38 days to start a business in SA compared to 25 in OECD countries and the cost of starting a business in this country expressed as a percentage of gross national income per capita is 9.1 compared against the 8.0 in OECD countries.

SBP found that it costs formal sector companies in South Africa R105,175 a year, on average, to comply with regulations. The organisation notes that compliance costs are pure red tape costs – the costs that accumulate because forms have to be understood, filled in, and submitted. This compliance cost does not include the efficiency costs of regulation, nor the payment of taxes, levies, or rates.

The World Bank study employed an index measuring the ease of hiring and firing workers. The index assigned a value between 0 and 100, with higher values representing more rigid regulations. SA was rated at 56 out of 100 on the Difficulty of Hiring index compared to the 26.2 average of OECD countries, and at 60 out of 100 on the Difficulty of Firing workers index compared to the 26.8 of OECD countries.

An unintended consequence of SA’s labour laws, which were designed to provide job security for the employed, is that they prevent those that want to work from negotiating contracts freely with potential employers. High costs and minimum wages reduce the employment opportunities of unemployed people with few skills who typically find employment in small and micro enterprises. The unemployed are prevented from gaining work experience while their productivity is not high enough to justify the wages employers would be compelled to pay them, leaving them in a most unenviable position. Without experience they can’t get jobs and without jobs they can’t get experience.

If government reduced the bureaucratic red tape and relaxed the statutory requirements that prevent people from getting jobs in the formal sector it would not be necessary for so many people to turn to the informal sector for employment. A labour surplus economy like South Africa, where there are large numbers of semi-skilled and unskilled workers, should not erect barriers to entry into the labour market. The ANC suggestion, hopefully not stillborn, to allow labour market forces to function unhindered for young people at the low end of the market, would benefit large numbers of jobless people if implemented. Young people would not have such a desperate struggle to get onto the first rung of the employment ladder.

Not unexpectedly, the already employed argue that weakening of job-security legislation and erosion of minimum wages will lead to increased poverty. In doing so they choose to ignore, or are totally uncaring about, the poverty of people who do not have jobs and have little prospect of getting jobs because they have been priced out of the labour market. It is demand for labour that improves the wages of workers, not laws. Labour law reform is needed to increase that demand if the jobs are to be created that will transform South Africa into a high-employment country.

Author: Jasson Urbach is an economic researcher at 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 Free Market Foundation.

FMF Feature Article / 5 July 2005 - Policy Bulletin / 20 October 2009

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