The World Bank's Private Sector Development blog notes that relaxing labor regulations (i.e. making it easier for employees to hire and fire workers) in Latin America would lead to more employment:
[O]n a net basis, making labor regulations more flexible in most countries will result in a net gain in employment. More workers will be fired, but even more workers will be hired as a result of increased flexibility. Only one country in the study (Nicaragua) would see no net gain, and a number of countries would see large net gains (e.g. Colombia and Paraguay).
So why not do it?
The tricky part is that workers who already have jobs will be naturally opposed to more flexible labor regulations. But there is a better solution than rigid regulations that keep marginal workers out of formal labor markets. As Dave argues, unemployment insurance could go a long way to softening the blow for those who lose their jobs.
At first glance, this seems like a plausible enough compromise, and perfectly in line with what John Ruggie called "embedded liberalism": a system of public institutions that smooth the convulsions of market economies while still retaining the dynamism and incentive structures that make market economies more productive than command economies. Variations of this approach still dominate the mixed systems of the industrialized world even after the collapse of the Bretton Woods system that first inspired Ruggie to coin the phrase.
But it's not clear that there is a direct link between the strength of a social safety net and attitudes towards labor market regulations. In many Western European countries, labor regulations are stronger than those in the U.S. and the safety net is more generous. This leads to dual rigidities in both systems. In much of Europe, workers with good jobs (esp. public sector jobs) tend to never lose them, and potential workers on the dole tend to stay there because their opportunities for employment are rarer and the generous welfare benefits incentivize stasis. In the U.S., easy hiring and firing in most industries leads to a more dynamic system, but less-generous unemployment benefits make transitions more painful and incentivizes workers to take the first job they can get even if it doesn't maximize their skills. So the European model leads to more structural unemployment, while the U.S. model leads to more cyclical unemployment. Both systems sacrifice some productivity in the bargain.
Many Latin American countries have chosen neither approach, instead protecting labor in the hopes that a social safety net won't be needed at all. This is fine if you are fortunate enough to get a good job, but it hurts those who cannot. Not only are the unfortunate often unable to break into the labor cartels, but they are also not protected by a welfare state. In many ways, this is the worst of all worlds. But it isn't clear that a flexibility-for-safety-net bargain is feasible. It will be difficult to persuade workers who benefit from the current system that reform is necessary. After all, most of them will never need a safety net; their jobs are secure in the status quo. Moreover, a stronger safety net will have to be paid for through higher taxation of those currently employed. A campaign platform of "increasing job insecurity + higher taxes" is not likely to garner much support.
In other words, political compromises are not made in a vacuum. The sort of grand bargain envisioned by the World Bank folks may make plenty of sense in the abstract, but only because they assume an unrealistic starting point for negotiations. When one considers the true positions of the parties involved, such a compromise looks almost impossible.
There's a reason why systemic transformations (like a re-organization of labor markets) tend to follow things like major wars and economic collapses: in normal times the status quo is entrenched; after crises there is no status quo. This is not to say that marginal improvements are not impossible in normal times, but major reforms are very difficult to achieve.