Skip navigation.

How do labour markets adjust to economic crises?

Rizwanul Islam, 13 December 2012

Although economic crises like the global economic crisis of 2008-09 are usually caused by economic factors, they affect the lives and livelihoods of people, and thus get transformed into social crises. This happens mainly through their impact on employment and labour markets. Hence, in order to address the challenge of social crises, it is necessary to understand how labour markets are affected by and adjust to economic crises.

The answer to the above question is likely to vary from country to country depending on their level of development and the structure of the economy. Here, I am focusing specifically on developing countries where large proportions of the people are engaged in the informal parts of the economy, and productivity and earnings are already low.

The World Bank’s World Development Report 2013 on jobs devotes some attention to the issue of labour market adjustment in response to economic crisis and acknowledges country level variations in adjustment patterns in terms of jobs lost or earnings declines. It concludes: “The less formalized the labour market, the more earnings shrank and the less the employment numbers gave away” (p.61).

In support of this conclusion, the report states: “In East Asia, where formal employment rates are very low, the average decline in GDP growth was 5.5 percentage points, and the total numbers barely changed” (p.61). The kind of conclusion mentioned above may tempt one to argue that if wages are flexible downwards, unemployment can be avoided. The reality, however, is more complex.

Labour markets in developing countries are not homogeneous; they consist of different segments, e.g., the more formalized modern sector consisting of manufacturing and modern service sectors and the less formal segment that includes a variety of activities. An economic crisis may affect these different segments in different ways.

The different mechanisms through which labour markets adjust include retrenchment of workers, reduction of wages, changes in the form of contract (e.g., from regular contract to casual one), and changes in the sector composition of employment, e.g., workers moving from manufacturing and construction to agriculture and other traditional sectors.  It would thus be rather simplistic to remain limited to quantity vs wage adjustment and to say one or the other worked.

Even with regard to adjustment in terms of employment numbers vs reduction in earnings, one has to look at the situation in a disaggregated manner. The following examples may be useful for purposes of illustration. In India, a sample survey carried out by the Ministry of Labour and Employment showed that half a million workers had lost their jobs during October-December 2008.

It is well known that the recession continued through the first half of 2009 and may have led to more retrenchments. In China, reports in early 2009 mentioned that around 20 million migrant workers returned to their villages due to lack of jobs. In Bangladesh, a number of export oriented sectors, e.g., textiles and jute goods reported job losses during 2008-09.

In countries like those mentioned above, workers who lose jobs from the modern sectors may not appear as unemployed in labour force surveys because in the absence of unemployment benefits, they usually end up in the informal segments of the economy. As the informal sector already acts as refuge for those who cannot be absorbed by the formal sector, further pressure on it may lead to reductions in wages and earnings.

So, on aggregate, one may find very little decline in total employment (or increase in unemployment) and labour market adjusting through declines in earnings. But it should be clear from the above examples that some sectors (especially the more modern parts that are closely linked to the global economy) did respond to the global economic crisis by retrenching workers. In other words, both quantity and price adjustments have been at work.

Economic crises cause changes in the composition of labour markets, and the global economic crisis was no exception. During economic booms, labour markets often adjust by taking in more workers on a contract basis. When the downturn comes, they are the ones to be retrenched first, the result of which may not show up in official data on unemployment.

The contract workers who are already in the informal segment of the formal sectors may suffer more by moving out to jobs with lower earnings that basically provide refuge from open unemployment. This kind of movement appears to have taken place in countries like Bangladesh and India where large numbers in the formal sectors are employed as contract workers. The survey in India mentioned earlier reported that the rate of retrenchment of contract workers was six times that of regular workers. In Bangladesh, those retrenched from the jute goods sector were mostly contract/temporary workers.

Another mechanism of adjustment that was at work was a reverse movement of workers towards agriculture and other rural activities and from one region to another. The former happened in China while in Indonesia there was large scale return migration of workers from plantations (that were affected by the global economic crisis) in Kalimantan and Sumatra to Java, a densely populated island with heavy pressure on the labour market. Such movement of workers has adverse implication for earnings of workers that, in turn, was caused by loss of jobs.

To conclude, the moot question is not just whether labour markets adjusted more through wages or unemployment. It is necessary to look at different mechanisms of adjustment that are at work.

  • Rizwanul Islam is an economist, and a former Special Adviser, Employment Sector, at the International Labour Office, Geneva.
Bookmark and Share