The Role of Labor Market Frictions in Structural Transformation – Kevin Donovan and Todd Schoellman

Despite the long recognition of the role played by the labour market in economic growth, recent work has primarily abstracted from frictions affecting how workers and firms come together in the production process. Yet, policy discussions continue to highlight the idea that sustained economic growth requires poor countries to remedy market failures that limit the private sector from creating more jobs. There is a need to understand the frictions that permeate the labour market in less developed countries, and how such frictions interact with cross-country differences in sectoral, occupational, demographic, and spatial composition both today and in the future.

There is ample indirect evidence of labour market frictions at the aggregate country-wide level. At a macro level, there are substantial gaps in average wages across sectors. However, understanding the link to both structural transformation and requisite policy responses requires information on the underlying forces driving such outcomes.

This paper will review existing evidence on labour market frictions in the developing world and will highlight the following questions: what are the underlying causes of labour market frictions in developing countries; do these frictions limit structural transformation and growth; do these frictions particularly impact specific groups of the population, such as women or low-skilled workers; what types of data and theory are required to better understand these questions?