The Role of Labour Market Frictions in Structural Transformation

Abstract

Growth is closely related to structural transformation, the reallocation of economic activity among sectors. A well-functioning labour market plays an important role in this process by enabling workers to find employment in the growing, higher-paying sectors, while a frictional labour market slows structural transformation and traps workers in poverty. We review the literature on the extent of labour market frictions and their role in slowing structural transformation in developing countries. The 3 main areas of focus are wage gaps and worker selection, the dynamism of labour markets, and specific labour market barriers. Evidence in each area points to the presence of frictions that hinder labour reallocation. The literature also suggests policies that may help remedy frictions and improve worker mobility. We conclude by noting several open questions that provide promising avenues for future work. This is an output of the Structural Transformation and Economic Growth (STEG) programme