DEPARTAMENTO DE ECONOMIA PUC-RIO. TEXTO PARA DISCUSSÃO N o. 398 LABOR MARKET REGULATIONS AND THE DEMAND FOR LABOR IN BRAZIL

DEPARTAMENTO DE ECONOMIA PUC-RIO TEXTO PARA DISCUSSÃO N o. 398 LABOR MARKET REGULATIONS AND THE DEMAND FOR LABOR IN BRAZIL RICARDO PAES DE BARROS IPEA CARLOS HENRIQUE CORSEUIL IPEA GUSTAVO GONZAGA PUC-Ro JULHO 1999

Labor Market Regulatons and the Demand for Labor n Brazl * Abstract Rcardo Paes de Barros IPEA Carlos Henrque Corseul IPEA Gustavo Gonzaga PUC-Ro The man objectve of ths study s to evaluate the mpact of the 1988 changes n labor market regulatons prescrbed by the new Consttuton on the level of employment and on the speed of employment adjustment n Brazl. From the many aspects of labor market regulatons, ths study concentrates on those that drectly nfluence varable labor and dsmssal costs. Evaluatng the mpact of changes n these costs on the level of employment and speed of adjustment s based on estmates of structural dynamc models for labor demand at dfferent ponts n tme before and after the 1988 consttutonal change. The emprcal strategy s to estmate such models from mcrolongtudnal monthly data for a sample of 5,000 manufacturng establshments, whch cover the perod from January 1985 to December 1997. To try to solate the effect of the consttutonal change on the parameters of the labor demand functon from the effects of the trade lberalzaton process and from the several stablzaton plans that also occurred by the end of the 1980s, we regress our monthly estmates of these parameters on a temporal ndcator of the 1988 consttutonal change, controllng for a varety of other macroeconomc ndcators. Key words: Labor Demand, Labor Regulatons, Manufacturng Establshments n Brazl JEL Classfcaton Number: J23 July 1999 * Ths paper was prepared as part of a broader research program on Labor Market Regulaton and Employment n Latn Amerca and the Carbbean, sponsored by the Inter-Amercan Development Bank. We wsh to thank the contrbuton of Mguel Foguel, Phllpe Lete, Rosane Mendonça, Danel Mlton, and Danel Santos. We also wsh to thank José Márco Camargo for hs comments and, IBGE, specally Wasmala Bvar, for the excellent support gven to ths project. We are responsble for the remanng errors. 1

1. Introducton Labor market regulatons are nvarably ntroduced wth two objectves: to mprove the welfare of the labor force, even at the cost of ntroducng some degree of economc neffcency, and to mprove effcency, when external factors and other labor market mperfectons are present. However, due to an unsutable orgnal desgn or unexpected changes n the economc envronment, labor market regulatons may eventually become nadequate, leadng to results contrary to ther orgnal goals. Hence, as a general rule, labor market regulatons (as any other market regulaton) need to be constantly evaluated and updated f ther orgnal goals are to be preserved. Evaluatons of the mpact of labor market regulatons on the level of employment and ts speed of adjustment to economc fluctuatons are the subject of major current mportance n Brazl. Most labor regulatons n Brazl date back to the 1930s and 1940s, wth very few modfcatons beng ntroduced up to 1988. Most of these labor regulatons are wrtten n the Consttuton and are, consequently, very hard to change. In 1988, however, a new Natonal Consttuton was enacted as part of the redemocratzaton process. Labor market regulatons underwent consderable changes n ths new Consttuton. On the whole these changes were made to gve the workers more protecton. Many analysts have been very crtcal about the benefts of these consttutonal changes. They clam these changes have not been wsely desgned and, consequently, are leadng to ncreasngly poor workng condtons and lower wages and a drop n the degree of employablty of the labor force n a new economc envronment that ncreasngly requres greater labor flexblty. As a consequence, labor legslaton reform has become a central tem on the current Congress agenda, partcularly after the recent leap n unemployment 1. Despte the mportance of evaluatons of the mpact of changes n labor legslaton on labor market performance, the number of such studes focusng on Brazlan labor markets has been very lmted 2. The relatvely small number of studes on the subject are, however, not the result of a lack of proper nformaton or dentfcaton devces. In fact, the relatve scarcty of studes contrasts sharply wth the wealth of nformaton avalable and promsng methodologcal possbltes for dentfyng the mpact of labor market regulatons. The man objectve of ths study s to evaluate the mpact of the 1988 changes n labor market regulatons on the level of employment and on the tme requred by frms to adjust ther employment level to economc fluctuatons. From the many aspects of labor market regulatons, ths study wll concentrate on those that drectly nfluence varable labor and dsmssal costs. Evaluatng the mpact of changes n these costs on the level of employment and speed of adjustment wll be based on estmates of structural dynamc labor demand models for every month from January 1985 to December 1997, usng mcro-longtudnal data on manufacturng establshments. A comparson of estmates for the short and long-run labor-cost elastcty of employment and of the speed of adjustment for perods before and after the enactment of the 1988 Consttuton s the man devce used to dentfy the mpact of changes n labor regulatons on labor demand. 1 Deseasonalzed unemployment n the sx man Brazlan metropoltan regons ncreased from around 5,7% n October 1997 to 7,5% n June 1999. 2 Some examples are Amadeo, E., Barros, R., Camargo, J.M., et al. (1995), Amadeo, E., Camargo, J.M. (1993), Amadeo, E., Camargo, J.M. (1996) and Málaga, G.T. (1992). 2

The study s organzed n eght sectons n addton to ths ntroducton. Secton 2 provdes a descrpton of the effect of the 1988 consttutonal change on labor costs, wth partcular attenton to ts mpact on dsmssal costs. The thrd secton descrbes the theoretcal dynamc labor demand model. Secton 4 dscusses, from a theoretcal pont of vew, the mpact of an ncrease n non-wage varable labor costs and dsmssal costs on the level of employment and speed of adjustment. Secton 5 presents the assumptons made to obtan an econometrcally feasble labor demand specfcaton. Secton 6 descrbes our emprcal strategy. Secton 7 descrbes the database. Secton 8 presents and dscusses the man emprcal results. Fnally, Secton 9 concludes. 2. The 1988 consttutonal change A new Brazlan Consttuton was enacted n 1988 as part of the process of redemocratzaton n Brazl durng the second half of the 1980s. Tradtonally, Brazlan consttutons are very detaled, stpulatng not only general rules, but also many specfc legal provsons. Most labor regulatons, for nstance, are wrtten n the Consttuton and are, consequently, very dffcult to amend. The new Consttuton of 1988, n partcular, consderably affected labor regulatons, causng changes n many labor codes that had remaned ntact snce the 1940s 3. Most of these changes, n tune wth the redemocratzaton envronment, ncreased the degree of the workers protecton. These changes, shown n Table 1, affected both ndvdual rghts and workers organzatons. The new Consttuton gave more freedom and autonomy to unons. The possbltes for government nterventon n unons were drastcally reduced. In fact, many mechansms of offcal nterference were elmnated as well as many restrctons of an nsttutonal nature used to lmt workers organzatons. Many regulatons on unon management were also weakened, ensurng more autonomy to unons durng electons of ther representatves and n ther decsons. From the pont of vew of ndvdual rghts, we can perceve mportant changes that ncrease varable labor costs and the level of dsmssal penaltes. The ncrease n protecton ensured by the new Consttuton consderably ncreased a frm s costs of employment. The maxmum number of workng hours per week dropped from 48 to 44 hours; the maxmum number of hours for a contnuous work shft dropped from 8 to 6 hours; the mnmum overtme premum ncreased from 20% to 50%; maternty leave ncreased from 3 to 4 months; and the value of pad vacatons ncreased from 1 to, at least, 4/3 of the normal monthly wage. The new Consttuton also consderably ncreased the level of dsmssal penaltes. It s worth mentonng that the changes altered the level of the penaltes but not ther nature. Tradtonally, Brazlan legslaton affects the cost of dsmssal through two channels. Frst, employers must gve notce to ther employees n the case of dsmssal. Moreover, between the notce and actual dsmssal workers are granted two hours per day to look for a new job, wth no cut n wages. Secondly, the law states that all workers dsmssed for no just cause must receve monetary compensaton pad by the employer. Pror to the 1988 Consttuton, notce had to be gven at least one month n advance. The 1988 Consttuton states that the perod of notce should be gven n proporton to the worker s tenure. However, snce no specfc law has ever regulated ths consttutonal devce, notce contnues to be gven, as before 1988, one month pror to dsmssal for all workers, ndependent of ther tenure. 3 One major excepton were the rules regulatng dsmssals that suffered major changes n 1966, when the FGTS was created. 3

In prncple, the need for notce would ncrease the cost of dsmssal only to the extent that, for a perod of one month, 25% of the hours of the dsmssed worker would be pad but not worked. In practce, the productvty of a dsmssed worker wll drop once he/she has been gven notce, mplyng an overall declne of well over 25% n hs/her contrbuton to producton. As a result, t s not uncommon for frms to pay a full salary to dsmssed workers, wthout ther beng requred to work a sngle hour. In other words, the cost of notce s actually between 25% and 100% of one month s salary, beng n practce closer to 100% than to 25%. However, t has not yet changed wth the 1988 Consttuton. Hence, t cannot be used as our source of varaton n labor regulatons. Wth respect to the monetary compensaton for dsmssed workers, the law states that a fxed percentage of the Fundo de Garanta por Tempo de Servço FGTS accumulated whle the worker was employed by the frm s to be pad to every worker dsmssed for no just cause. The FGTS s a fund created by the mltary regme n 1966 to serve as an alternatve to the job securty law prevalng at that tme. In practce, all new contracts after 1966 adopted the new system, snce both employees and employers preferred t. FGTS basc characterstcs are: (1) each worker n the formal sector has hs own fund, n other words, t s a prvate fund, nstead of a sngle fund for the workers as a group; (2) to buld the fund of each ndvdual worker, the employer must contrbute every month wth the equvalent of 8% of hs employee s current monthly wage, consequently, the accumulated FGTS of a worker n any gven frm s proportonal to the worker s tenure and hs/her average wage over hs/her stay n the frm; (2) the fund s admnstrated by the government; (3) workers have access to ther own fund only f dsmssed wthout just cause or upon retrement 4 ; (4) f they resgn they are not granted access to ths fund, (5) on dsmssal, workers have access to ther entre fund, ncludng all funds accumulated n prevous jobs, plus a penalty n proporton to ther accumulated fund n the job from whch they are beng dsmssed. There was a fourfold ncrease n the value of ths penalty as a result of the 1988 Consttutonal change. Before 1988, ths compensaton was equal to 10% of the cumulatve contrbuton of the current employer to the worker s FGTS. After 1988, ths penalty was ncreased to 40% of the employer s cumulatve contrbuton to the worker s FGTS. Ths change n legslaton wll be one of the fundamental sources of varaton used throughout ths study to estmate the mpact of frng costs on the long-run level of employment and on the speed of employment adjustment. Quanttatvely, the penalty s approxmately 40% (10% pror to 1988) of the worker s current monthly wage per year n the frm, snce, at a monthly rate of 8% of the monthly wage, the FGTS accumulates at a rate of approxmately one full monthly salary per year n the job. Ths compensaton was certanly very small pror to 1988. In fact, under the former Consttuton, the worker had to be employed n the frm for at least ten years n order for the compensaton to reach the magntude of one monthly salary. Now t takes 2.5 years n the job for the fne to reach the value of a month s salary. As far as ncentves are concerned, t s worth emphaszng that the penalty s pad by the employer to the employee, as opposed to the employer s payng nto a socal fund held for all workers as a group. In other words, the dsmssed worker receves the penalty on an ndvdual bass. Ths characterstc of the law has major negatve effects 4 There are a few exceptons. Workers can use ther FGTS as a part of the payment for acqurng ther home. They also can use t to pay for large health expenses. 4

on the workers behavor, gvng them sgnfcant ncentves to nduce ther own dsmssal (see Macedo (1985), Amadeo e Camargo (1996)). There are two man reasons for these negatve effects. On one hand, we see that the FGTS penalty s receved ndvdually by workers f they are dsmssed. Furthermore, beng fred s the chef mechansm to acheve access and control over ther overall FGTS. On the other hand, there are strong ncentves for workers to seek access to ther FGTS. Frst, because the government has poorly managed the FGTS, typcally generatng negatve real returns or returns well below market rates. Secondly, because, due to shortsghtedness or credt constrants, workers may be heavly dscountng the future. In short, the facts that (a) all dsmssal penaltes are mmedately receved ndvdually by the dsmssed worker and (b) beng dsmssed s the chef mechansm for workers to acqure control over ther own fund that s poorly managed by the government, gve them consderable ncentves to nduce ther own dsmssal after a certan tme n any job. Lastly, t s worth mentonng that, despte the 1988 fourfold ncrease n the FGTS penalty, t s not clear that, even now, ths penalty consttutes a major constrant to dsmssals or even a major fracton of overall dsmssal costs. For nstance, the cost of advance notce may easly reach the value of a full month s salary. Consequently, the costs of advance notce tend to be hgher than the dsmssal compensaton pad to all workers wth tenure of less than 2.5 years. Snce most employment relatonshps n Brazl are short, employers may be more senstve to the cost of advance notce than to the value of the dsmssal compensaton. 3. A structural model for labor demand In ths study we estmate a structural dynamc labor demand model as smple as possble usng longtudnal data on establshments. The basc theoretcal model assumes that each frm, at each pont n tme t, chooses the level of employment, n (t), n order to maxmze the expected present value of profts,.e., each frm chooses n (t) n order to maxmze E [ R( n ( t + r), p ( t + r), θ( t + r, ) ( t + r ) r t ρ µ r= 0 ( t + r) w ( t + r) n ( t + r) ( n ( t + r), η( t + r) )] δ C (1) where R s the revenue functon and C the employment adjustment cost functon. In ths equaton we are mplctly assumng that labor s the only nput undergong adjustment costs. Hence, at each pont n tme, the revenue functon, R, can be obtaned by choosng the level of producton and of all non-labor varable nputs that maxmze a current profts condton on a gven choce for employment, and the state of the technology. As a consequence, the arguments of the revenue functon can be dvded nto three groups: (a) level of employment, n (t), (b) prce of all other varable nputs relatve to the product prce, p (t), and (c) all factors determnng the state of technology. We dvde the factors determnng the state of technology nto two groups: (a) a vector of parameters defnng the overall form of technology at each pont n tme, θ(t), that s common to all frms, and (b) a certan frm and tme-specfc technologcal nnovaton, µ (t). The second term n equaton (1) s the drect cost of labor. In ths equaton, w (t) s the real wage rate 5 pad by frm at tme t and δ(t) the rato between the overall 5 The real wage rate s obtaned dvdng the nomnal wage rate by the product prce. 5

varable cost of labor and the wage rate. We are mplctly assumng that all non-wage varable costs are proportonal to wages wth the proportonalty constant and common to all frms but possbly tme-varyng due to changes n the legslaton. Fnally, the cost of adjustment s assumed to be a functon of the net change n employment, n (t) = n (t) - n (t-1), and a parameter η(t). Ths parameter may vary over tme to capture changes n the economc envronment and n the labor legslaton, but t s common to all frms, ndcatng that all frms face the same adjustment cost. In short, accordng to ths model the form of technology and labor costs may vary freely over tme. However, dosyncratc shocks of a frm can only affect technology. Labor costs are determned by frm-specfc wages and a legslaton that s common to all frms. In order to obtan an explct soluton to ths problem of maxmzaton, we ntroduce a seres of smplfyng assumptons. Frstly, we assume that the revenue functon s separable n the followng sense: R 1 ( n ( t ) p ( t ), ( t ), µ ( t) ) = F n ( t ), θ ( t) 2 ( ) + [ ( p ( t ), θ ( t )) ( t )] n ( t ), θ G + µ Under ths assumpton, the Euler equaton assocated wth maxmzng equaton (1) s gven by 6 : F n C 1 2 ( n ( t), θ ( t ) G p ( t), θ ( t) ( ) + µ ( t) ( t) w ( t) + δ ( ( ) η( ) + ρ { ( ( + ) η( )} = 0 n t, t Et C n t 1, t + 1 (2) We further smplfy ths model by assumng that the revenue functon s lnearquadratc and the adjustment costs s quadratc,.e., we assume that F 1 11 ( n ( t), θ ( t ) = θ ( t) n ( t) θ 12 2 ( t) ( ) 2 n t and C ( n ( t), η( t) ) η = 2 ( t) ( n ( t) ) 2 where θ 1 (t) = (θ 11 (t),θ 12 (t)). Furthermore, we assume that all frms n the same sector undergo the same prce of nputs. As a result, G m 2 ( p ( t), θ ( t) ) = ϕ ( t) where I s ndcates whether frm belongs to sector s,.e., I s =1 f frm belongs to sector s and I s =0 otherwse. Under these addtonal assumptons the Euler equaton becomes s= 1 s I s 6 We use F n and C to denote the dervatves of the F and C functons wth respect to ther frst arguments. 6

θ 11 m 12 ( t) µ ( t) + ϕ ( t) I δ ( t) w ( t) θ ( t) n ( t) η( t) n ( t) + ρη( t) ( E { n ( t + 1) } n ( t) ) = 0 + s= 1 s s Under the assumpton that parameters θ 12 (t) and η(t) are tme-nvarant and that Et θ 11 + s s s= 1 s= 1 m m 11 ( t 1) + µ ( t + 1) + ϕ ( t + 1) I δ ( t + 1) w ( t + 1) = θ ( t) + µ ( t) + ϕ ( t) I δ ( t) w ( t) the soluton of ths equaton s gven by n ( t) λn ( t 1) where λ s mplctly defned by ( 1 λ) 11 = + θ 12 θ s= 1 m ( t) + µ ( t) + ϕ ( t) I δ ( t) w ( t) s s t s s θ 12 ( 1 λ)( ρλ)η λ = 1 (3) 4. The mpact of an ncrease n non-wage labor costs and frng costs In ths secton we dscuss, n the realm of ths smple theoretcal model, what the mpact of an ncrease n non-wage varable labor costs and frng costs would be on the short and long-run levels of employment, n (t) and n, and the speed of adjustment, λ. In order to get analytcal equatons for these mpacts, t s necessary frst to obtan an equaton for the level of employment n the long run. If we assume that the state of technology, prces, wages and labor legslaton wll reman constant at ther current level, then employment n the long run would converge to m 1 11 n = θ ( t) + µ ( t) + ϕ s ( t) I s δ ( t) w ( t) (4) 12 θ s= 1 Under ths theoretcal formulaton, an ncrease n non-wage varable labor cost at tme t s captured by an ncrease n δ(t), the rato between varable labor costs and the wage rate. An ncrease n ths parameter would ncrease the response of employment to changes n wages resultng, consequently, n a declne n employment both n the short and long run. More precsely, and n δ ( t) = 7 ( 1 λ) n 1 = w ( t) 12 δ ( t) θ Snce the speed of adjustment, λ, s only a functon of technology, through parameter θ 12, and of the adjustment cost functon, through parameter η, an ncrease n varable costs, δ(t), would have no mpact on the speed of adjustment. An ncrease n frng costs s captured, n the model, by an ncrease n the cost of adjustment, more specfcally by an ncrease n parameter η. Ths parameter, however, θ 12 w ( t)

does not enter the employment equaton drectly. It affects employment only through ts effect on the speed of adjustment, λ. Hence, to nvestgate the mpact of an ncrease n the cost of adjustment, we have to begn by computng ts mpact on the speed of adjustment. By dfferentatng equaton (3) we obtan λ η = θ ( 1 λ )( 1 ρλ ) + ( 1 2ρλ + ρ ) η 12 > 0 The nequalty holds snce both λ and ρ must le n the unt nterval (0,1). Ths expresson shows that as expected an ncrease n the cost of adjustment ncreases λ and so decreases the speed of adjustment. The mpact on the level of employment can then be obtaned by evaluatng the mpact of an ncrease n λ on the level of employment n the short and long run. In the long run the level of employment s gven by equaton (4) that does not depend on λ. Hence, n the context of ths smple theoretcal model, an ncrease n the cost of adjustment has no effect on the level of employment n the long run. In the short run, however, an ncrease n the cost of adjustment may have a postve or negatve mpact on the level of employment. The sgn wll depend on whether the level of employment s ncreasng or declnng. In fact, n λ ( t ) n ( t ) Snce an ncrease n the cost of adjustment would decrease the speed of adjustment and so ncrease λ, the level of employment would ncrease (reduce) n the short run whenever employment s declnng (growng). = - 1 - λ 5. Econometrc specfcaton To obtan an emprcally feasble econometrc labor demand specfcaton, one must be more specfc about the frm-tme technologcal nnovaton, µ (t). We assume that ths nnovaton conssts of three underlyng components,.e., we assume that µ ( t ) = β + γ ( t ) + U t ( t ) where β captures a frm-specfc tme nvarant technologcal component, γ(t) an aggregated tme-specfc technologcal shock and U (t) captures all other technologcal shocks. The presence of the frst two components allows us to assume, wthout any loss of generalty, that the average of U (t) over tme and across frms s always zero. However, snce the econometrc model wll also nclude sectoral ndcators, I s, we must assume that the average of U (t) wthn each sector s also zero,.e., we assume that for every s, E[U (t) I s =1]=0. To dentfy the parameters of the model, addtonal assumptons are requred. Probably the smplest route to obtan dentfcaton s to assume that U (t) s an exogenous movng average process. Accordngly, we assume that 8

E [ U ( t) U ( t p) ] 0 = for all p>k 1. We also assume that although these technologcal shocks may be correlated wth the recent evoluton wages, they are uncorrelated wth the evoluton of wages n the past,.e., [ U ( t) w ( t p) ] 0 E = for all p>k 2. Notce that f U were an exogenous movng average process of order k = max( k 1, k 2 ), then these two assumptons would be mmedately satsfed. Gven ths specfcaton for the technologcal nnovaton, equaton (2) may be rewrtten as where n m * * * * ( t) ( t) + β + ϕ ( t) I δ ( t) w ( t) + λn ( t 1) U ( t) = α (5) s s + s= 1 ( ) 1 λ α + θ 11 ( t) = θ ( t) ( t) δ ϕ U β * * * s * 12 γ 1 λ 12 θ ( t) = β 1 λ θ ( ) = δ ( t) t 12 1 λ 12 θ ( t) = ϕ ( t) 1 λ 12 θ ( t) = U ( t) The presence of α(t) and β * n equaton (5) poses some drawbacks for estmaton. The presence of α(t) makes estmaton of the other parameters unfeasble n a pure tme seres context, unless some functon form for α(t) s mposed. In a cross-secton envronment the dffculty s mposed by the natural correlaton between β * and n (t-1). To solve ths problem we must rely on longtudnal nformaton. When ths type of nformaton s avalable we can take frst dfferences to obtan n m * * * ( t) = α( t) + ϕ s ( t) I δ ( t) w ( t) + λ n ( t 1) + U ( t) s= 1 s as long as the rato between the overall varable cost of labor and the wage rate δ(t) s tme-nvarant. Ths equaton has the advantage of elmnatng the dosyncratc component β *. Nevertheless, t stll cannot be estmated as a multple regresson snce * E[ n ( t 1) U ( t) ] 0 However, t follows from the assumptons made prevously about U (t) that s and * [ ( t p) U ( t) ] 0 E n = 9

* [ ( t p) U ( t) ] 0 E w = for all p>k+1. Hence, the model can be estmated f we use past values of employment and wages as nstruments. Ths s the procedure we use n our emprcal analyss. In the estmaton we use two alternatve values for k (1 month and 10 months). Under the assumptons made on U (t), all values of employment and wages lagged at least k+2 perods would be vald nstruments. However, from a practcal pont of vew t s necessary to lmt the number of nstruments. In ths study we use as nstruments 6 lags for employment and 6 lags for wages,.e., we use as nstruments employment and wages lagged, k+2,..., k+7 months. Hence, to mplement ths econometrc procedure t s necessary to count wth panel nformaton at least k+7 long on frm-specfc employment and wages. Based on ths econometrc model, t s possble to estmate α(t), λ, δ* and ϕ s (t). To obtan the other parameters of the producton functon, θ 12, and of the cost functon, η, some addtonal nformaton s requred. In ths study, to recover these orgnal parameters we assume that the dscount rate, ρ, and the rato between the unt cost of labor and the wage, δ, are known and equal to 0.95 and 1.8 respectvely. Gven the knowledge of these two parameters and estmates for λ and δ*, estmates for the underlyng parameters θ 12 and η can be obtaned va λˆ θˆ 12 1 = δ * δˆ and λδ ˆ ηˆ = δˆ * 1 ρλˆ 6. Emprcal strategy 10 ( ) In ths study, to estmate the lnear dynamc model for labor demand specfed n the sectons above, we use monthly longtudnal nformaton for a sample of 5,000 manufacturng establshments. Snce the man goal s to fnd evdence of the mpact of the 1988 consttutonal change on the parameters of the labor demand functon, the strategy could not be to estmate a sngle model for the entre perod. One possblty would be to estmate two sets of parameters, frst usng data from the years before 1988 and then data from recent years. If the 1988 consttutonal change had mportant effects on labor costs, we should fnd a consderable declne n the speed of adjustment (.e., an ncrease n λ) and an ncrease n the response of employment to changes n wages, δ*. The avalable data, however, allows us to do much better. Instead of beng restrcted to estmatng just two labor demand functons for a pre-1988 and a post-1988 perod, the avalable data allows for demand functons to be estmated for a varety of perods n tme. In fact, t s possble to obtan monthly estmates of the parameters of the demand functon. Ths strategy has at least two advantages over the strategy of estmatng just two models for a perod before and after 1988. Frst, t s easer to mplement snce, the econometrc model s essentally estmated n a cross-secton. Ths feature of the estmaton procedure makes estmatng the standard errors much easer snce, n ths case, t s not necessary to estmate the temporal correlaton patterns of the technologcal shocks.

Secondly and more mportantly, the estmaton of a model for every month has the great advantage of allowng a precse dentfcaton of the exact pont n tme where the parameters have changed. A precse dentfcaton of the moment when the parameters changed can provde mportant nsghts n the queston of whether the consttutonal change s the real force behnd the changes n the demand for labor. For nstance, f the parameters began to change long before or long after 1988, we would become suspcous about the causal lnk between the 1988 consttutonal change and those n the demand for labor. For these reasons, we use the avalable nformaton to obtan monthly estmates of the parameters of the labor demand functon. 7 The longtudnal data avalable covers the perod from January 1985 to December 1997. Our frst task was to obtan monthly estmates of the parameters of the demand functon coverng most of ths perod. The need for vald nstruments determnes that parameter estmates could only be obtaned from md-1986,.e., 18 months after the actual sample nformaton begns. The monthly estmate of demand functons was, however, just the frst step n our econometrc strategy. Snce the Brazlan economy underwent a process of trade lberalzaton and was subject to a seres of stablzaton plans at the same tme as the change n the Consttuton, changes n the parameters of the labor demand functon that may have occurred over ths perod cannot be mmedately attrbuted to the consttutonal change. To solate the effect of the consttutonal change on the parameters of the demand functon, we regress our monthly estmates of these parameters on a temporal ndcator for the 1988 consttutonal change, D t, controllng for a varety of other macroeconomc ndcators, M t. Snce the precson of estmates vares consderably over tme, to control for ths source of varaton we use as our dependent varable the parameter estmate dvded by ts correspondng standard error. More specfcally, we estmate the followng regressons λˆ( t) = a1 + b1d( t) + c1m ( t) + e1 ( t) sλ ( t) and ˆ δ ( t) = a2 + b2d( t) + c2m ( t) + e2 ( t) sδ ( t) where s λ (t) and s δ (t) are the standard errors of λ ˆ( t ) and ˆ δ ( t ), and D(t) = 0 f t refers to a perod pror to 1988 and D(t) = 1 otherwse. We nclude the followng as macroeconomc ndcators: (a) the real GDP growth rate; (b) degree of openness measured by the rato of total trade (exports plus mports) to the GDP; (c) nflaton rate; and (d) nflaton volatlty measured by the nflaton standard devaton. ly dummes and a lnear trend were ncluded n all regressons 8. These regressons are estmated by ordnary least squares usng monthly data coverng the perod June 1986 to December 1997. Postve and statstcally sgnfcant estmates for b 1 and b 2 would then be taken as evdence that the 1988 consttutonal change had an mportant effect on the 7 At ths pont t s worthwhle mentonng that, although the demand for labor s estmated for every month, n the estmaton procedure the parameters θ 12, η and δ must be at least locally tme nvarant. The estmated parameters are consstent only f ths assumpton s vald. If the parameters θ 12 and η change over tme equaton (2) would not be the soluton of the Euler equaton. Moreover, f δ vares from one month to the next, the frst dfference made to elmnate the frm-specfc tme nvarant technologcal component, β *, would stll work, but wll generate a dfferent functon form to be estmated, snce n ths case δ * would not factor out. 8 The source of the GDP data s the IBGE. The data for exports and mports was calculated n jont FUNCEX/IPEA work. Lastly, we used the offcal nflaton ndex to measure nflaton. 11

demand for labor and consequently on the level of employment and the speed of adjustment. 7. The database: Pesqusa Industral Mensal PIM In ths study we estmate the demand for labor usng monthly longtudnal nformaton from the Pesqusa Industral Mensal (PIM). PIM s a monthly ndustral establshment survey conducted by IBGE (Brazlan Census Bureau) coverng the entre country. It s a longtudnal survey of a stratfed sample of approxmately 5,000 manufacturng establshments employng fve workers or more. The orgnal panel was selected n md-1984 jontly wth a supplementary sample used to replace establshments n the orgnal panel when they eventually close. The panel covers the perod from January 1985 to the present. The sample was desgned to allow most statstcal analyses to be conducted separately for sx geographcal regons and 22 manufacturng sectors. The survey collects nformaton on labor nputs, labor costs, turnover, the value of producton and some others. The data on labor nputs ncludes both employment and the total number of hours pad. The survey has three major lmtatons n terms of measurng labor nputs. Frst, the nformaton covers the total number of hours pad, but not the actual number of hours worked. Secondly, all data refers only to the personnel drectly nvolved n producton. Fnally, there s no nformaton on the qualfcaton of the labor force employed. In relaton to labor costs, two types of nformaton are avalable: (a) total value of contractual wages (.e., value of wages and salares as specfed n labor contracts) and (b) total value of payroll. For the purposes of ths study, the payroll data seem to be more nformatve snce t ncludes, n addton to contractual wages, the payment for overtme, commssons and other ncentve schemes, such as a productvty premum. It also ncludes all frnge benefts, pad vacatons, and any addtonal payments for hazardous actvtes, nght shfts, and other compensatng schemes. 9 Despte the fact that the payroll data covers a wde varety of labor costs, t does not nclude all of them. Major exceptons are the employer s contrbutons to socal securty, tranng programs and other socal programs. Fortunately, however, these contrbutons as fractons of contractual wages have been farly constant over tme, except for a sgnfcant change at the end of the 1980s. Hence, for each establshment n the survey we use essentally three peces of nformaton: (a) employment level, (b) total number of hours pad, (c) total payroll. Based on these three varables we construct two measures for varable labor cost. These two measures are obtaned by dvdng total payroll by the level of employment and the total number of hours pad, respectvely. For labor nput we use both avalable measures: employment and hours pad. As a result, each demand model s actually estmated twce dependng on whether labor nputs are measured by employment or hours pad. We wll refer to the one based on employment level as model 1 and as model 2 to the one based on hours pad. In the frst step of the regresson analyss we aggregate some macroeconomc ndcators mentoned on last secton. The source of the GDP data s the IBGE. The data 9 In ths study, all nformaton on contractual wages and payroll has been deflated usng the sector s specfc wholesale prce ndex, except for pharmaceutcal, plastcs, textles, and perfumes, soap and candles sectors. All monetary values referred to constant Reas at December 1997. 12

for exports and mports was calculated n jont FUNCEX/IPEA work. Lastly, we used the offcal nflaton ndex to measure nflaton. Before we move to the labor demand estmates, we present some basc statstcs from our sample of establshments. Fgures 1a-b present the monthly evoluton of the average level of the two measures of labor nput used n the study. These fgures reveal that frms n our sample employ 200 to 300 workers who are pad a total of 45,000 to 70,000 hours per month along the perod analyzed. The average number of hours pad per month per worker n our sample s around 230 hours. Notce that a fracton of the hours pad are not actually worked. For nstance, ncluded n the hours pad s at least one day off per week (usually Sunday), whch s pad but not worked. All these fgures reveal that, over the 1985-97 perod, employment and hours pad per manufacturng frm declned consderably, wth the total declne concentrated n the frst two years of the 1990s. The man goal of ths study s precsely to determne to what extent ths declne can be assocated to the 1988 consttutonal change or to other macroeconomc changes that marked the performance of Brazlan economy over ths perod. Fgures 1c-d show the monthly evoluton of our two measures for labor costs. These fgures reveal that average wages for producton workers n Brazlan manufacturng were, most of the tme, between R$600 and R$800 per month, leadng to an hourly wage rate between R$2,50 and R$3,50 10.These fgures reveal an overall upward trend n wages over the perod coupled wth at least four cyclcal fluctuatons. These cycles very closely match a seres of stablzaton plans that marked the perod 1985-1994 (see Fgure 1e). 8. Emprcal results The 1988 consttutonal change brought an ncrease n labor costs, n partcular, n frng costs. To the extent that ths change was of substantal mportance, t would lead to an ncrease n the response of employment to wages, δ * and φ, and to a reducton n the speed of adjustment (.e., an ncrease n the coeffcent on lag employment, λ). We estmate labor demand models for each month, from June 1986 to December 1997. Although we have nformaton snce January 1985, the need for vald nstruments determnes that parameter estmates could only be obtaned from md-1986,.e., 17 months after the actual sample nformaton begns. As already mentoned n the prevous sectons, two labor demand models were estmated, dependng on the choces of measures for labor nputs. Moreover, two estmates are obtaned for each model, dependng on how far n the past we select the nstruments. In total, four estmates for the labor demand functon are obtaned. In each case we drectly estmate two basc parameters: (a) the coeffcent on lag employment, λ, and (b) the coeffcent on current wages, δ*. We also obtan estmates for the longrun mpact of change n wages on employment (φ) and other structural parameters (θ 12 and η). Fgures 2.1a to 2.2b provde estmates of the monthly evoluton of the short-run mpact of changes n wages on employment, δ t *. Fgures 3.1a to 3.2b show correspondng estmates for the coeffcent on lag employment, λ t. Snce the estmates vary consderably from month to month we also compute a trmmed 12 months movng 10 The exchange rate was 1,11 R$/US$ n December of 1997. 13

average. We adopted a two-step procedure to calculate ths movng average. Frst, we elmnate all values n the lowest and hghest tenths of the dstrbuton. Secondly, we calculate 12 months movng averages wth the remanng estmates. The averages are weghted, usng the nverse of the standard errors of each estmate as weghts. Based on these movng average estmates for the basc parameters of the model (λ t and δ t *), we obtan estmates for the long-run effect of wages on employment, φ t. These estmates are presented n Fgures 4.1a to 4.2b. Based on three-year averages of the temporal evoluton of these parameters and the values chosen for ρ and δ, we obtan estmates for some mportant remanng structural parameters of the model: θ 12 and η. These estmates are presented n Fgures 5.1a-6.2b. Fgures 2 and 4 provde clear evdence that both employment and hours pad declne as labor costs rse. These fgures, however, provde no clear evdence that ether the short or long-run response of employment to labor costs ncreased as a consequence of the 1988 consttutonal change 11. Fgure 3 gves no evdence that the speed of adjustment was sgnfcantly affected by the 1988 consttutonal change. In fact, Fgure 3 reveals a modest contnuous ncrease n the speed of adjustment, contrary to what would be expected from a dscrete ncrease n frng costs. It s worth mentonng, however, that the estmates for λ have the correct sgned and are statstcally sgnfcant, at least when we use the number of employed workers as a measure of the labor nput. These estmates, however, are consderably smaller (estmates for λ are around 0.5) than what s commonly obtaned from tme-seres studes. Although the same pattern s observed when we use the number of hours pad, some pont estmates became negatve and t becomes consderably less precse. Fnally, Fgure 3 reveals that, as we choose nstruments further nto the past (.e., as k ncreases), the estmated values for λ declnes, ndcatng that seral correlaton among technologcal shocks may serously bas λ upwards. The nterpretaton of the basc parameters would be much easer f all varables were n logs. The specfcaton wth all varables n logs s also more close related to the tradton n labor demand models. For these reasons, we re-estmate all prevous models changng all varables from levels to logs. Fgures 7.1a-9.2b shows that the man results are robust to the log specfcaton. As n the basc model, these Fgures provde no clear evdence that the 1988 consttutonal change had any sgnfcant mpact on ether the magntude or the speed of the response of labor nputs to labor costs. These Fgures deserve a few addtonal comments. Frst, they show that the short and long term wage elastctes are around - 0.2 and -0.4, respectvely. Secondly, t s worth mentonng that the estmates for the coeffcent on lag of employment remans very close to 0.5, as the case n the basc model. Thrdly, t should be noted that the further the nstruments are n the past, the smaller the estmated coeffcents on lag employment, another pattern common to the basc model. To summarze the evdence about the effect of the 1988 consttutonal change on labor demand, we regress monthly estmates of the parameters λ and δ * on an ndcator for the consttutonal change and controls for a set of basc macroeconomc varables. 11 The extremely hgh values reported when we use hours pad as the employment varable are due to the defnton of ths varable, that s, the total amount of hours, or n another way, the number of hours worked n a month by each employee tmes the number of employees. So ths fgure reflects how many of the total hours are changed n response to a change n the wage varable. 14

These regressons also nclude monthly dummes and a lnear trend. The results are presented n Tables 2 and 3. If the consttutonal change actually ncreases labor costs and, as a consequence, has an mportant effect on the demand for labor, then the estmated coeffcents for the ndcator of consttutonal change would be postve and statstcally sgnfcant n the regressons nvolvng both parameters. Ths would be the case, snce an ncrease n varable labor costs would ncrease δ and hence δ *, whereas an ncrease n frng costs would ncrease the cost of adjustment and reduce the speed of adjustment leadng to an ncrease n λ. Contrary to these expected results, n none of the regressons presented n Tables 2 and 3 dd we fnd any evdence ndcatng that the 1988 consttuton change had any sgnfcant effect on the labor demand functon. All estmates of the consttuton ndcator coeffcent are not statstcally sgnfcant, despte the regresson R 2 reach values close to 0.4. 9. Summary and conclusons In 1988, a new Consttuton was enacted as a central part of the Brazlan redemocratzaton process. Ths new Consttuton brought sgnfcant changes n labor legslaton. Overall, the changes were made to ncrease the amount of protecton to workers, resultng, n partcular, to sgnfcant ncrements n dsmssal penaltes. Ths study s an attempt to estmate the mpact of these changes n varable labor costs and dsmssal costs brought by the 1988 consttutonal change. We nvestgate the mpact of these changes on the parameters of the demand for labor. In partcular, we nvestgate the mpact of these changes on the short and long run wage elastcty and on the speed of adjustment. From a theoretcal pont of vew we expect that an ncrease n varable non-wage labor cost would ncrease the response of employment to wages and reduce the overall level of employment. Wth respect to the mpact of an ncrease n dsmssal costs, a reducton was expected n the speed of adjustment wth the mpact on the level of employment n the short run dependng on whether employment was rsng or declnng. If employment were to declne, an ncrease n dsmssal costs should slow down the declne n employment n the short run. To verfy these hypotheses emprcally we estmate a dynamc labor demand model usng longtudnal nformaton from a survey of 5,000 Brazlan manufacturng establshments. To evaluate the mpact of the 1988 consttutonal change on the parameters of the demand for labor, we use mcro-dmenson of our panel data to obtan monthly estmates for all parameters of the labor demand functon. The estmated parameters were consstent wth the theory. The short and longrun wage elastctes are around 0.2 and 0.4, respectvely. The estmated speed of adjustment s, however, much faster than tradtonally estmated from tme seres data. In fact, the coeffcent on lag employment s close to 0.5 n our monthly model. Typcal estmates from tme seres would ndcate fgures closer to 0.8 or even 0.9. If the consttutonal change had a major mpact, we should observe an mportant change n these parameters around 1988. The estmates presented n Fgures 2 and 3, however, provde no evdence at all that the consttutonal change had any effect. Nonetheless, these fgures reveal consderable temporal fluctuatons n the coeffcents that could be explaned by macroeconomc events. These macroeconomc events could 15

offset a hypothetcal consttuton effect. To verfy ths possblty we regress our monthly estmates for the parameters of the demand functon on a ndcator for the consttuton change and a seres of macroeconomc ndcators. The results presented n Tables 2 and 3 ndcate that the 1988 consttuton change does not seem to have any sgnfcant effect on the labor demand functon. References: AMADEO, Edward, BARROS, Rcardo Paes de, CAMARGO, José Márco et al. Brazl. In: MÁRQUEZ, Gustavo (ed.). Reformng the labor market n a lberalzed economy. Washngton: IADB, 1995. p. 35-78. AMADEO, Edward, CAMARGO, José Márco. Labour legslaton and nsttutonal aspects of the Brazlan labour market. Labour, v.7, n.1, Sprng. 1993.. Insttuções e o mercado de trabalho braslero. In: CAMARGO, José Márco (ed.). Flexbldade do mercado de trabalho no Brasl. Ro de Janero: FGV, 1996. BURGESS, S. Asymmetrc Employment Cycles n Brtan: Evdence and an Explanaton. The Economc Journal v.102, p.279-90, 1992. MACEDO, Roberto Bras Matos. Dferencas de saláros entre empresas prvadas e estatas no Brasl. Revsta Braslera de Economa, v.39, n.4, p.448-73, Oct./Dec. 1985. MÁLAGA, Gullermo Tomás. Dynamc labor demands: cases of nterest for Brazl. In: 15. Encontro Braslero de Econometra, 1992, Campos do Jordão (SP). Anas... São Paulo, SBE, 1992. 16

Table 1: Changes ntroduced by the new Consttuton promulgated n October 1988 Pre-Consttuton Post-Consttuton Indvdual Rghts 1- Maxmum workng hours per week = 48 hours 1- Maxmum workng hours per week = 44 hours. 2 - Maxmum daly journey for contnuous work shft = 8 hours. 2- Maxmum daly journey for contnuous work shft = 6 hours. 3 - Mnmum over-tme remuneraton = 1,2 of the normal wage rate. 3- Mnmum over-tme remuneraton = 1,5 of the normal wage rate. 4 - Pad vacatons = at least the normal monthly wage. 4- Pad vacatons = at least 4/3 of the normal monthly wage. 5 - Maternty lcense = 3 months (1 before and 2 after the brth). 5- Maternty lcense = 120 days. 6 - Prevous notfcaton of dsmssal = one month. 6- Prevous notfcaton of dsmssal = proportonal to senorty (to be regulated by a future law). 7 - Fne for non-justfed dsmssal = 10% of Fundo de Garanta 7- Fne for non-justfed dsmssal = 40% of Fundo de Garanta por Tempo de Servço (FGTS). por Tempo de Servço (FGTS). 8- Creaton of paternty lcense of 5 days. 9- Proft-sharng (regulated by a 1996/97 law). Unons Organzaton A) The Mnstry of Labor had the rght to ntervene n the unons A) The Mnstry of Labor s forbdden to ntervene n the unons. and depose ther board of drectors. B) Every unon had to be regstered and approved at the Mnstry of Labor. B) Unons do not need to be regstered and approved at the Mnstry of Labor. C) Natonal representaton of unons was allowed only n exceptonal cases. C) Natonal representaton of unons s allowed. D) Unon s representatves were elected by a mnmum quorum of 2/3 of the D) Unon s representatves are elected followng unon s own rules. members n the frst ballotng, ½ n the second ballotng and 2/5 n the thrd ballotng. In the case of no mnmum quorum for the electon, the Mnstry of Labor could chose unon s drectors and call another electon. E) Workers (employers) unons were allowed to be formed by only one E) Workers (employers) unons are allowed to be formed by dfferent types type occupatonal (economc) category. of occupatonal (economc) categores. F) Unon s decson to go on strke had to be approved by a mnmum F) Unon s decson to go on strke follows unon s own crteras. quorum of 2/3 of unon s members n the frst callng and 1/3 n the second callng. G) In case of strke, notfcaton to the employer had to be done G) In case of strke, notfcaton to the employer has to be done 5 days n advance. 48 hours n advance. H) Strkes were forbdden n actvtes consdered fundamental (e.g. energy H) There are not any more sectors n whch strkes are forbdden: n essental and gas servces, hosptals, pharmaces, funeral servces); publc actvtes, workers and employers are responsble for the provson of mnmum servants were not allowed to go on strke. servces; publc servants (excludng mltary personnel) are allowed to go on strke. Source: CAMARGO, José Márco, AMADEO, Edward J. J. Labour legslaton and nsttutonal aspects of the brazlan labour market. Ro de Janero:PUC, 1990. NASCIMENTO, Amaur Mascaro. Incação ao Dreto do Trabalho. Edtora LTr. São Paulo, 1993. Table 2: Regresson results - k=1 Model 1 Model 2 Dependent varable Lagged employment (λ) Labor cost (δ*) Coeffcent P-value Coeffcent P-value Indcator for the consttutonal change -1.542 0.771-1.861 0.583 GDP growth rate -81 0.840-69 0.788 Degree of openness 8.617 0.225-3.998 0.379 Inflaton rate 11.377 0.291-8.461 0.221 Inflaton volatlty 2.491 0.156 1.460 0.194 Adjusted R 2 0.358 26 Indcator for the consttutonal change -5.578 0.393 2.320 0.433 GDP growth rate 0.743 0.136-0.177 0.432 Degree of openness -1.499 0.864-2.111 0.594 Inflaton rate 20.985 0.115 9.474 0.117 Inflaton volatlty -0.329 0.879-0.807 0.410 Adjusted R 2 0.135 65 Table 3: Regresson results - k=10 Model 1 Model 2 Dependent varable Lagged employment (λ) Labor cost (δ*) Coeffcent P-value Coeffcent P-value Indcator for the consttutonal change 10.597 0.771-3.750 0.583 GDP growth rate 49 0.840-0.248 0.788 Degree of openness -5.272 0.225 1.961 0.379 Inflaton rate -8.950 0.291-5.417 0.221 Inflaton volatlty -2.192 0.156 0.849 0.194 Adjusted R 2 0.213 57 Indcator for the consttutonal change -3.242 0.393 1.526 0.433 GDP growth rate 0.247 0.136-30 0.432 Degree of openness 3.200 0.864-7.195 0.594 Inflaton rate 16.996 0.115 14.988 0.117 Inflaton volatlty -0.701 0.879 1.363 0.410 Adjusted R 2 0.194 0.133 17

Basc Statstcs 300 Fgure 1A Average Employment per Establshment 280 260 240 220 200 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Source: Based on "Pesqusa Industral Mensal" (PIM). Fgure 1B Average Number of Hours Pad per per Establshment 70 65 60 55 50 45 40 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Source: Based on "Pesqusa Industral Mensal" (PIM). 18