PUBLIC POLICY INTERVENTION IN LABOUR MARKETS: REGIONAL VARIATION IN ENFORCEMENT OF LABOUR LAWS IN ESTONIA. Jaan Masso 1 University of Tartu

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1 PUBLIC POLICY INTERVENTION IN LABOUR MARKETS: REGIONAL VARIATION IN ENFORCEMENT OF LABOUR LAWS IN ESTONIA Jaan Masso 1 University of Tartu Introduction For Central and Eastern European (CEE) economies labour market flexibility, i.e. the ability of the labour market to allocate the resources in the most efficient way (Hahn, 1998) has become a relevant issue for economic policy towards labour markets. The enlargement of the European Union to the East and the requirements of the European Monetary Union increase pressure for labour flexibility whereas rigid labour markets in the monetary union may results in growing market disequilibrium, e.g. unemployment (Paas et al. 2003). One of the most important aspects of the multidimensional concept of labour market flexibility is employment protection legislation (henceforth also EPL). It includes provisions aiming at defending employees from arbitrary dismissals or cushioning the effect of economic cycles on employment. The public policy intervention in the labour market may be seen to provide important social protection for the workers as well as to correct for market failures, e.g. encouraging productivity growth through higher investments into human capital, greater loyalty of workers etc. (OECD 1999). However, excessive replacement of market mechanisms with economic policy may slow down adjustment to economic shocks, discourage hiring and job creation and benefit workers with unlimited contract at the expense of unemployed and limited duration contract workers. So the aim of labour market policy should be maintaining a proper trade-off between labour flexibility and social protection of employees. In empirical studies for transition economies the measures of formal legislation have found to have only a small effect on labour market performance, e.g. unemployment (Cazes 2002). But the problem is that the efficiency of regulations imposed by economic policy depends on that to what extent law enforcement agencies control for the fulfilment of these regulations, punish violations etc. Differently, how flexible is the obeyance of laws. Even strict laws may have little influence on the economy, if economic agents often violate them or if law enforcement agencies are weak. Poor enforcement may correct for distortions induced by too restrictive economic policy, by increasing flexibility and thereby employment, reduce labour costs, that are in fact important goals for economic policy. Though these issues might be rather important for transition economies, the existing papers on labour market flexibility in CEE countries (among them, Cazes 2002, Svejnar 2002, Riboud et al. 2002) limited attention to the strictness of formal legislation only. 1 jaan@ec.ut.ee 346

2 In this paper we analyze how the resolution of labour disputes arising from violations varies in Estonia regionally, e.g. across counties. In principal, the more often are workers complaints against violations approved, the higher is the effective strictness of regulations. We use data on the resolution of labour disputes in labour dispute commissions formed at local labour inspectorates, and information on the resolution of cases arising from labour contracts in courts. The only other study we know at the moment on the variation of labour law enforcement at regional level is the one by Macis (2001) on Italian regions. In particularly, the aim is to see, how local labour market conditions affect the degree of law enforcement: more adverse conditions may trigger decisions of labour dispute organs to be more favourable to employees, so that real costs of dismissing employees increase. Measurement of the employment protection legislation Employment protection legislation encompasses any set of regulations that limit the employers ability to dismiss the worker without delay or cost (Pissarides 2001). Usually the measurement is done by some indexes, where individual indicators of EPL strictness (statutory compensations payments in case of dismissals, regulation of unfair dismissals, regulation of temporary employment and collective dismissals etc.) are attached numerical scores, converted into a common scale and averaged with higher weights attached to economically more important provisions. The figure below depicts the values of the OECD (1999) EPL strictness index for selected CEE and EU countries. As we can see, for both Estonia and the CEE countries in general, the employment protection legislation is basically as strict as in the member countries of the European Union on the average Latvia Lithuania Estonia Bulgaria Czech Hungary Poland Slovakia Slovenia Baltic s CEEC Germany UK Italy France EU OECD USA Figure 1 The index of EPL strictness in selected EU and CEE countries (min 0, max 6). Source: Eamets and Masso (2003); OECD (1999); Riboud et al. (2002). 347

3 However, there are several problems with the existing indexes. Bertola, Boeri and Cazes (2001) have listed several of these, e.g. most EPL indicators are based on legal constraints that apply in each country and are not suitable for tracking differences across countries and time in the degree of enforcement of employment protection. At least to our knowledge, so far the papers on the issue of labour market flexibility in CEE countries have only estimated and discussed the strictness of applicable legislation. Still, it is indispensable to analyze the enforcement of employment protection legislation, as at least for some of the transition countries there is a lot of evidence on the violation of the regulations on employment relationships. The data on the violations discovered by Estonian Labour Inspection shows that, in a very high proportion of enterprises (46 % of inspected enterprises in 1999), laws regulating labour relations are sometimes violated. It means that although the legal regulations of the labour market seem to be in place at the moment, the increasing administrative capacity may increase the control over observance of the regulations, so that labour market flexibility will be reduced due to better law enforcement. In a somewhat different, but analogous, area of research, law and finance, Pistor, Raiser and Gelfer (2000) by studying legal change in shareholder and creditor rights in transition economies also came to the conclusions that legal transplants and extensive legal reforms are not sufficient for the evolution of effective legal and market institutions. Resolutions of labour disputes in labour dispute commissions In Estonia the individual labour disputes may be resolved either by agreement between the employer and the employee, by labour dispute committees or by the courts (Individuaalse töövaidluse lahendamise seadus, 2000). Labour dispute commissions were established according to the Individual Labour Dispute Resolution Act (valid since ) and since this time most of the labour disputes have been resolved in labour dispute commissions. The labour dispute committee consists of the chairman of the labour dispute committee and of the representatives of both employees and employers. It is established within the local labour inspectorates of the Estonian Labour Inspectorate. The chairman of the labour dispute commission is the official of the local labour inspection. There are time limits applied, during which appeals may be made to the labour dispute bodies: in general 4 month, but in order to dispute the correctness of termination of the employment contract, 1 month (Employment Contracts Act, paragraph 143). In the case if the termination of labour contract is considered to be unjustified, the employee has the right to require reinstatement to the previous position. For interpreting this legal provision, employment protection legislation is considered the more restrictive, the more often the reinstatement into the previous job is made available to the employee in the case of dismissal (OECD 1999). When the employee is reinstated, the labour dispute body (either commission or court) prescribes the enterprise to pay him/her the compensation in the amount of the 348

4 average wage for the time he/she has been forced to miss work. If no reinstatement is applied, the compensation in the amount of up to 6 months average wage is to be paid. In Estonia employees have been quite active in submitting complaints to labour inspectors, e.g. in cases per 100 employees, which is much more than the respective numbers in Latvia and Lithuania (in 2000 respectively 0,19 % and 0,22 %; see also Table 1). Also, workers have won quite a high percentage of cases, e.g. in % were satisfied and 65 % completely; still this may have been induced by the frequent occasion of violations in the first place. The number of cases brought before the court was much smaller (in ,1 % of the number of employees on average), and the number of cases won by workers have been on average 60 %. Over the years percentage of approved litigations has increased in labour dispute commissions (from 79 % in to 84 % in 2002), while in courts it has decreased from 68 % in 1998 to 50 % in One factor that may be the reason for frequent complaints is the low level of trade union membership (about 16 % in Paas et al. 2003): the stronger the union within the firm, the more likely that disputes are solved before going to labour dispute organs (Bertola et al. 1999). Another relevant factor is how well are unfair dismissals defined in the law and how many degrees of freedom are left for enforcement agencies in interpreting employment protection regulations (Ibid.). In Estonia dismissals are allowed for various grounds like employees misconduct, unsatisfactory performance, economic redundancy (Law of Employment Contract, paragraph 86), so that there does not seem to be any big legal vacuum in dismissals regulation. Table 1 The enforcement of EPL in Baltic States and EU countries Year Number of Percent of Number of Per cent of cases complaints to cases won cases brought won by workers inspection/employees (%) by workers before tribunal Latvia % 88% 0.06% n.a. Lithuania % 68% n.a. n.a. Estonia % 85% n.a. n.a. UK 1995 n.a. n.a % 38% Italy 1995 n.a. n.a % 51% France 1995 n.a. n.a % 74% EU 1995 n.a. n.a % 50% US 1995 n.a. n.a % 48% Source: Authors calculations; Bertola, Boeri, Cazes Tööinspektsioon ( Lietuvos Respublikos Valstybinė darbo inspekcija ( Latvian State Labour Inspectorate ( 349

5 Next we look at the enforcement of EPL at the regional level (across counties) in Estonia. Empirical evidence in Italy pointed to a strong link between law enforcement and regional labour market conditions (Macis 2001): a significant and positive relationship was found between the incidence of long-term unemployment and the number of cases brought before courts. Indeed, Nickell and Layard (1999) have pointed out that higher unemployment can be the source of pressures to increase the strictness of employment protection. The intuition is that judges and labour dispute public employment service officials feel that under heavy labour market conditions workers should have higher level of job protection than in buoyant labour market conditions (Boeri et al. 2002). Figure 2 shows the relationships between the unemployment and total litigations per employee. The positive effect of unemployment on litigations may be due to that local labour market conditions influence the propensity of laid-off workers to appeal against dismissal (as explained by Boeri et al. 1999). Anyway, the relationship is not overly strong either, due to two outliers (Saaremaa and Valgamaa). Total litigations/employees 1.20% Valga Saare 1.00% Põlva Jõgeva 0.80% Ida-Viru Tartu Järva 0.60% VõruTallinn/Harju Viljandi Rapla Lääne 0.40% Pärnu Lääne-Viru 0.20% 6% 11% 16% 21% Unemployment Figure 2 Unemployment and litigiocity rates in Estonian counties, Second relation of interest is the one between litigiocity rates and percentage of cases favourable to workers. In the Figure 3 there is a positive correlation between the number of complaints by employees and the percentage won by workers. The intuition behind the observed relationship could be that high likelihood of favourable rulings in commission may induce the workers to bring their cases into the commission in the first place. However, for Italian regions Macis (2001) found the relationship to be strongly negative. It was argued that an explanation behind the counterintuitive result could be selection bias (Ichino et al. 2000): firms will fire employees only if they can be fairly confident that employees do not appeal to the court, or if they do, then the court will not make decision in favour of the employee. As a result, the cases reaching the stage of trial are those in which the position of the firm is on average much stronger than in the whole population of dismissals. 350

6 Total litigations/employees 1.20% 1.00% 0.80% 0.60% 0.40% 0.20% Lääne Jõgeva Valga Saare Põlva Ida-ViruTartu Võru Tallinn/Harju Viljandi Rapla Pärnu Järva Lääne-Viru 50% 60% 70% 80% 90% 100% % cases favourable to workers Figure 3 Litigiocity rates and % of cases favourable to employees, averages Perhaps surprisingly, the proportion of cases favourable to workers shows practically no dependence on unemployment rate in the particular county. Normally we would expect that higher unemployment rate and poor prospects to find a new job induces fired people to apply against their dismissal. The possible explanation could be again the aforementioned selection bias: if firms anticipate that workers appeals will be treated with sympathy due to poor labour market conditions, firms will layoff workers only when they are fairly confident to have a strong case (Boeri et al. 1999), so that the positive relationship disappears or becomes even negative. % cases favourable to workers 100% 90% 80% 70% 60% 50% Järva Saare Võru Pärnu Valga Tartu Rapla Tallinn/Harju Lääne-Viru Lääne Viljandi Põlva Jõgeva Ida-Viru 5% 10% 15% 20% Unemployment Figure 4 Per cent of cases favourable to employees and unemployment rate, averages of

7 Resolution of labour disputes in courts In this section we review the evidence on the resolution of cases arising from employment contracts in courts. The Republic of Estonia Ministry of Justice has provided the data 2. In most of the 15 counties there are only one court; for counties with more than one court the data was summed up across courts. The total number of court cases is much smaller than the total number of cases in labour dispute commissions: for , there were in average 607 cases in courts regarding employment contracts, while the average number of cases in labour dispute commissions was on average 3200 in That is actually expected whereas the resolution of disputes in labour dispute commission is meant to precede the resolution in the court (The Law of the resolution of Individual Labour Disputes 2000). Figure 5 shows positive relationship between the incidence of unemployment and the total number of court cases per employee. However, the relationship is mainly drawn by three counties with heavy labour market conditions: Jõgevamaa, Põlvamaa and Ida-Virumaa. Number of court cases per employee 0.30% 0.25% Ida-Viru 0.20% Jõgeva Põlva 0.15% Tallinn/Harju Saare 0.10% Lääne-Viru Valga Tartu Lääne 0.05% Pärnu Viljandi Rapla Võru Järva 0.00% Unemployment Figure 5 Number of court cases per employee and the unemployment rate across, averages Unfortunately we do not have any information regarding, whether lawsuits have been decided in favour of the employee or the employer, and we only know the proportion of cases decided in favour of the claimant. However, we assume that the employees have usually made the claims, whereas in labour dispute commissions the number of employers claims has been rather negligible (Labour Inspection 2001). The Figure 6 shows the negative relationship between the number of litigations and 2 The data is available from the author upon request. 352

8 the percentage of cases favourable to employee; for cases in labour dispute commissions the relationship used to be positive. However, we would like to mention that in some counties there are only a very small number of cases (less than 10) resolved each year, so that the idiosyncrasies in the data may drive the results. For the Estonia as a whole, 62 % of court cases were solved in favour of the claimant (who, as we argued, should be the employee usually), while in labour dispute commissions this percentage was 73 %. We would rather expect the opposite, whereas in labour dispute commissions also the representatives of the employers are present. The explanation might be that some of the workers claims found unjustified in labour dispute commissions are appealed to courts, so that among the cases arriving at courts workers position is weaker on average than among cases solved in labour dispute commissions. Anyway, both numbers are fairly high compared to those available for other countries. For instance, in the 9 member countries of the European Union workers won on average 50 % of the cases in 1995 (Bertola et al. 1999). Percentage of cases favourable to claimant 90% 80% 70% 60% 50% 40% 30% Võru Valga Tallinn/Harju Lääne Järva Rapla Lääne-Viru Viljandi Saare Tartu Pärnu Põlva Jõgeva Ida-Viru 0.00% 0.05% 0.10% 0.15% 0.20% Number of court cases per employee Figure 6 Court cases per employee and percentage of cases favourable to claimant, averages Finally, when we look at the percentage of cases favourable to the claimant vis-à-vis unemployment rate, we see a negative relationship, contrary to the negligible relationship between those variables for the labour dispute commissions. So for the courts the selection bias seems to drive the results: in counties with high level of unemployment courts are expected to make decisions favourable to employee and workers often apply to court, so due to the relatively high stringency of the effective employment protection only those cases reach the trial stage in those counties where employers position is rather strong. 353

9 Percentage of cases favourable to claimant 80% 70% 60% 50% 40% 30% Tallinn Valga Võru Lääne-Viru Lääne Rapla Viljandi Pärnu Tartu Saare Järva Jõgeva Ida-Viru Põlva 20% Unemployment Figure 7 Percentage of cases favourable to employee and rate of unemployment, averages Source: Ministry of Justice; Statistical Office of Estonia Conclusions. In this paper we analyzed the available data on the resolution of labour disputes in Estonia across counties. The resolution of labour disputes is important for the enforcement of labour legislation. The latter is an issue for Estonia, whereas violations of labour laws are quite frequent in enterprises. We used data on the labour dispute resolutions both in labour dispute commissions and in courts. There is much bigger number of cases in the labour dispute commissions than in the courts. In Estonia much more complaints have been handed in to the labour inspectors than in Latvia and Lithuania. At the regional level we saw that there is a positive effect of unemployment and the proportion of decision favourable to employees on the number of litigations per employee. Although unemployment is not associated with how favourable are the decision of labour dispute commissions on employees, possible selection bias may affect the results. The data on the resolution of labour disputes in courts has shown that unemployment affects positively the number of court cases and negatively the percentage of cases favourable to claimant (who, as we argued, should usually be the employee). The reason for this may be that if employees forecast decisions to be more favourable to employees in case of higher unemployment, only those cases reach the trial stage where employers position is rather strong. In the future the analysis of additional data could well complement our analysis. For example, we did not have data on the average time between the start of the 354

10 procedure and the decision of the labour dispute commission or court. That variable could measure the degree of efficiency of local administrative and judicial systems (Boeri et al. 2000). Secondly, more distinct data on the adjudications would help to deepen the analysis, e.g. if employer is found guilty in unfair dismissals, then how often it results in reinstatement and often only in compensation payment. Third, is the decision affected by worker s characteristics (like ability to find a new job, coverage with social security system)? Altogether we are convinced that the topic of labour law enforcement deserves further studying for both Estonia and CEE countries in general. References 1. Bertola, G., Boeri, T., Cazes, S., Employment protection and labour market adjustment in OECD countries: Evolving Institutions and variable enforcement. ILO, Employment and training papers 48, 103 pp. 2. Boeri, T., Garibaldi, P., Macis, M., Maggioni, M., Adaptability of labour markets: a tentative definition and a synthetic indicator. Milan, June Cazes, Sandrine, Do labour market institutions matter in transition economies? An analysis of labour market flexibility in the late nineties. International Institute for Labour Studies, Discussion paper 140/2002, 33 pp. 4. Davis, S., Haltiwanger, J. (1992); Gross Job Creation, Gross Job Destruction and Employment Reallocation. In: Quarterly Journal of Economics, Vol. 107, No. 3, pp Eamets, R., Masso, J., Labour Market Flexibility and the Employment Protection Regulation in the Baltic States. Forthcoming in the Working Paper Series of the Tallinn Technical University. 6. Hahn, F., Labour market flexibility and welfare, Quaderni del Dipartimento di Economia Politica, No. 223, Universita degli Studi di Siena. 7. Ichino, A., Polo, M., and Rettore, E., Are Judges Biased by Labor Market Conditions? The Selection of Firing Litigations for Trial in an Italian Firm, mimeo, June Individual Labour Dispute Resolution Act. Individuaalse töövaidluse lahendamise seadus. ( , with amendments ). [ 9. Labour Inspection/Tööinspektsioon, Statistika. [ 10. Macis, M., Regional Labour Market Conditions and EPL Enforcement in Italy, unpublished manuscript, Referred through: Boeri, T., Garibaldi, P., Macis, M., Maggioni, M., Adaptability of labour markets: a tentative definition and a synthetic indicator. Milan, June Nickell, S., Layard, R., Labor Market Institutions and Economic Performance, Handbook of Labor Economics, Volume 3C, Chapter 46, Elsevier Science, OECD, Employment Outlook. Paris. 13. Paas, T., Eamets, R., Masso, J., Rõõm, M., Labour Market Flexibility in the Baltic States: Macro Evidences. University of Tartu, Faculty of Economics and Business Administration Working Paper Number Pistor, K., Raiser, M., Gelfer, S., Law and Finance in Transition Economies. EBRD Working Paper

11 15. Riboud, M., Sanchez-Paramo, C., Silva-Jauregui, C., Does Eurosclerosis Matter? Institutional Reform and Labour Market Performance in Central and Eastern European Countries. in eds. by Bernard Funck and Lodovico Pizzati, Labour, Employment and Social Policies in the EU Enlargement Process. World Bank, Washington, pp Svejnar, Jan, Labour Market Flexibility in Central and East Europe. William Davidson Institute Working Paper Number 496, 32 pp. 17. The Republic of Estonia Employment Contracts Act. Eesti Vabariigi Töölepingu seadus. ( ) [ Kokkuvõte MAJANDUSPOLIITIKA SEKKUMINE TÖÖTURULE: TÖÖSUHTEID REGULEERIVA SEADUSANDLUSE TÄITMISE TAGAMINE EESTIS REGIOONITI Jaan Masso Tartu Ülikool Euroopa Liidu ittalaienemine ja Euroopa Rahaliidu nõuded tõstavad survet tõstmaks tööturgude paindlikkust, s.t nende võimet jaotada ressursse majanduses kõige efektiivsemal viisil. Paindlikkust vähendavad majanduspoliitikast tulenevad tööturu regulatsioonid, tööseadusandlus. Kuigi kehtivate seaduste mõttes pole Eestis töötajad mitte vähem kaitstud kui Euroopa Liidu riikides keskmiselt, esineb arvukalt töösuhteid reguleerivate seaduste rikkumisi, mistõttu seadusandluse tegeliku ranguse määrab ära suuresti see, kuidas töövaidlusorganid (Eestis töövaidluskomisjonid ja kohtud) töövaidlusi ning töötajate kaebusi lahendavad, milline on seaduste täitmise paindlikkus. Regulatsioonide eiramine võib tihti suurendada tööturu paindlikkust ja seeläbi parandada tööhõivet ja vähendada tööjõukulusid, mis on olulised majanduspoliitilised eesmärgid. Käesoleva artikli eesmärgiks oli vaadata, kuidas töövaidluste lahendamine varieerub Eestis regiooniti. Osutus, et nii tööpuuduse määr kui ka töövaidluskomisjonide kalduvus teha töötajatele soodsamaid otsuseid on positiivselt seotud töövaidluskomisjonidesse töötaja kohta esitavate avalduste arvuga. Samas seos tööpuuduse ja töötajate kasuks tehtud otsuste protsendi vahel praktiliselt puudus. Töölepingut puudutavate kohtuasjade arv oli samuti seotud positiivselt tööpuudusega, samas viimane oli negatiivselt seotud hageja (kes peaks tavaliselt olema töötaja) kasuks tehtud otsuste osakaaluga. Põhjuseks võib olla see, et kui tööandjad ennustavad kõrgema tööpuudusega regioonis kohtuotsuseid olevat suhteliselt soodsamad töötajatele, siis neis regioonides jõuavad kohtusse ainult asjad kus tööandja positsioon on küllaltki tugev. 356