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March 31, 2005
The Cost Of Labor Market Regulation
Microeconomic flexibility, by facilitating the process of creative destruction, is at the core of economic growth in modern market economies. The main reason why this process is not infinitely fast is the presence of adjustment costs, some of them technological, others institutional. Chief among the latter is labor market regulation. While few economists would object to such a view, its empirical support is rather weak. In this paper we revisit this hypothesis and find strong evidence for it... We find that job security regulation clearly hampers the creative-destructive process, especially in countries where regulations are likely to be enforced. Moving from the 20th to the 80th percentile in job security, in countries with strong rule of law, cuts the annual speed of adjustment to shocks by a third while shaving off about one percent from annual productivity growth. The same movement has negligible effects in countries with weak rule of law.
The job security measures in the study include indexes of grounds for dismissal provisions, protections regarding dismissal procedures, notice and severance pay provisions, and constitutional protection of employment procedures. As the authors explain:
The rules on grounds of dismissal range from allowing the employment relation to be terminated by either party at any time (employment at will) to allowing the termination of contracts only under a very narrow list of “fair” causes. Protective dismissal procedures require employers to obtain the authorization of third parties (such as unions and judges) before terminating the employment contract. The third variable, notice and severance payment... is the normalized sum of two components: mandatory severance payments after 20 years of employment (in months) and months of advance notice for dismissals after 20 years of employment... The four components... described above increase with the level of job security.
To give you an idea of the results, the United States is somewhere near the median in terms of the estimated speed of adjustment to sectoral productivity shocks. (Technically, it is in the third quintile among the 60 countries in the study, where the quintiles are arranged from slowest to fastest.) Great Britain has an estimated speed near, but slightly higher, than that of the U.S. Japan and Germany are slightly below the mean of the second quintile. Belgium has the lowest estimated speed of adjustment, France has the third lowest (just ahead of Kenya). The highest? Hong Kong, although generally speaking developing countries seem to dominate in the top tier.
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Employment protection saps productivity
Plenty of research has been done on the impact of employment protection legislation on labour markets and the wider economy. But a lot of it has been fairly inconclusive and empirically weak. Not so a recent Boston Fed working paper, Effective Labor Re... [Read More]
Tracked on Mar 31, 2005 2:19:43 PM
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