Employment Protection Legislation. What are we talking about? Set of norms and procedures followed in case of dismissal of redundant workers. Act as deterrent:

Employment Protection Employment Protection LegislationLegislation

What are we talking about?

Set of norms and procedures followed in case of dismissal of redundant workers.

Act as deterrent: protect workers with permanent contracts from the risk of early termination of their employment contract

Decisions involve also third parties: legitimacy of a layoff ultimately depends on court ruling

Outline

• Measures and cross-country comparisons

• Theory– a neutrality result– removing risk neutrality– EPL with rigid wages– EPL as a tax– two-tier regimes

Outline (cont.)Outline (cont.)

• Empirical evidence– Cross-country analyses– Within country studies– Endogeneity of EPL

• Policy issues– How much protection should EPL provide? – Whom should EPL protect?

• Why does EPL exist?

Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.

Measures

• Surveys of employers (possibly personnel managers of multinational firms) and workers (perceptions of security)

• Expert evaluations• Country rankings of Employment

Protection compiled by OECD (also LaPorta et.al., 2003), providing quantitative measures of qualitative features

Measures and cross country comparisons

Measures

OECD index of strictness transforms into a scalar measure information on the following dimensions of EPL:– definitions of “just cause” for individual dismissals

(economic and disciplinary)– statutory severance pay– minimum notice period – procedural obligations to be fulfilled before the

dismissals – additional regulations for collective dismissals


also hiring restrictions considered

• Lenght of the trial or probatory period

• Restrictions to the use of temporary work (e.g. Agency Work) and of fixed-term contracts

• Rationale: insofar as hiring restrictions increase the costs of replacements, they deter dismissals


How compiled?

Two-step procedure (OECD, Emo 2004, Annex 2.A1)

1. Conversion of 18 indicators in 0-6 scores

2. Calculation of weighted averages of the scores in different areas (individual dismissals of regular workers, collective dismissals, temporary work) and overall


Shortcomings of this index

• Arbitrary weighting of the different components of employment protection (e.g., regulations on collective dismissals worth 40% of those on temporary contracts)

• Interactions among features: e.g., stricter EPL for “regular” contracts involves more use of temporary contracts (misleading in “dual” systems, transiting from “rigidity” to “flexibility”)

• Nothing on enforcement


Enforcement matters

• In some countries (e.g., Japan and US), more than legal provisions, there are contractual provisions

• Conciliation practices, lenght of the judicial procedure, percentage of rulings favourable to workers act as a threat to dismissals

• Notice that these enforcement features are not measured by available indicators; we measure at best EPL, Employment Protection Legislation


Country rankings and evolution

Australia Austria

Belgium

Canada

Czech Republic

Denmark

Finland

France

Germany

Greece Hungary

Ireland

Italy

Japan Korea

Mexico

Netherlands

New Zealand

Norway

Poland

Portugal

Slovak Republic

Spain

Sweden

Switzerland

Turkey

United Kingdom United States

0

1

2

3

4

5

2003

0 1 2 3 4 5 Late 1990s

Index of overall strictness of collective dismissals

Australia

Austria Belgium

Canada

Denmark

Finland

France

Germany

Greece

Hungary Ireland

Italy Japan Korea

Mexico

Netherlands

New Zealand

Norway

Poland

Portugal

Spain

Sweden

Turkey

United Kingdom

United States 0

1

2

3

4

5

20

03

0 1 2 3 4 5 1990

Index of the overall strictness of EPL

Reforms concentrated on temporary contracts

Australia

Austria

Belgium Canada Denmark

Finland France

Germany Greece

Hungary Ireland

Italy

Japan Korea Mexico

Netherlands

New Zealand

Norway Poland

Portugal

Spain Sweden

Turkey

United Kingdom

United States 0

1

2

3

4

5

2003

0 1 2 3 4 5 Late 1990s

Index of regulation of regular employment

Australia

Austria

Belgium

Canada

Denmark Finland

France

Germany

Greece

Hungary Ireland

Italy

Japan Korea

Mexico

Netherlands New Zealand

Norway

Poland

Portugal Spain

Sweden

Turkey

United Kingdom United States 0

2

4

6

2003

0 2 4 6 1990

Index of regulation of temporary employment

Stylized facts about reforms

• Some convergence in overall EPL

• Driven almost entirely by reforms of temporary contracts: dual track reforms

• However inertia in country rankings: Spearman rank correlations in overall strictness is .9

• Rankings change adjusting for enforcement


Economically relevant distinction

• 2 components of the EPL tax: Transfers (TR) from employers to employees and Deadweight Costs (C) to third parties, such as legal and procedural costs, jurisprudence, etc.

• T=TR+C (In Italy C=20% of T)• TR can be negotiated, and hence incorporated

(discounted) ex-ante in wage contracts • while “deadweight costs”, C, cannot

Theory

A Neutrality result (Lazear, 1990)

• EPL is only TR. Under:– competitive product market (w=MP)

– competitive labour market (no unions)

– flexible wages (no wage floors)

– risk-neutral agents (u(w)=w), interested only in average wages over the period

TR has no effects on employment and wages. Contracted away

Theory

Contract neutralising TR (Lazear)

• Without TR, for periods offers w, which equals labour productivity as we are in competitive labour market

• Introducing TR, the contract provides w’=w-TR/ * < w for t< *

and w”= w+iTR > w for t> *

Where i is the interest rate

Theory

Example of 2 periods contract

• Suppose jobs last 2 periods and have marginal productivities MP1 and MP2 respectively

• Without EPL, in competitive labour market

• Introducing TR at 2 (i.e., W2= W2 +TR), this can be offset by lowering entry wage by an amount B such that the following condition is satisfied

Theory

i

MPMP

i

WW

112

12

1

i

TRB

i

WW

i

TRWBW

1

or 11

21

21

Graphically

W

1 2

W - TR/ (1+ i)

Theory

(W + TR)/ (1+ i)

t

W

Rationale

• Between t=0 and t=1 the worker transfers to the firm TR

• Between t=1 and t=2 the worker receives the transfer

• Bonding: contract as yield on bond TR; initially the worker buys the bond, then firm pays to the worker interest on the bond; end of the contract TR is given back to the worker

Theory

Intuition

• Mandated transfer from the employer to the worker can be undone by a “voluntary” transfer of the same size from the worker to the employer. Ex-ante same cost for the firm with and without EPL

• This works only if the employer succeed in extracting a payment from the worker when the contract begins (the worker must be willing to pay the “fee” upon signing the contract)

Theory

Removing risk neutrality

• Risk averse workers would suffer a welfare loss from a bonding arrangement

• Utility losses associated with income fluctuations

• Workers will ask for monetary compensations for this loss. Costs increase for the employers

Theory

With rigid wages

• Two countries both with rigid wages, but EPL only in Rigidland (R), not in Flexiland (F)

• Same technologies: Y=Ai log L

• Ai can be Ah (good times)>AL (bad times)

• Probability p and (1-p) respectively

• Wages fixed at w

Theory

Flexiland

L maximizes F = Ai log L – w L

Implying w=Ai/L thus under good times higher employment

Employment variations

L=(Ah-AL)/w when from bad to good

L=-(Ah-AL)/w when from good to bad

Average LF = (pAh+(1-p)AL)/w

Theory

Rigidland

Too costly to adjust L to shocks. Firms choose average L and stick to it

L maximizes R = (p Ah+(1-p)AL) log L – wL

Implying LR =(p Ah +(1-p) AL)/w =LF

Theory

Thus

• Average employment levels are the same in F and R

• More fluctuations in F than in R• With risk-neutral agents, country F is more

efficient as under any state of the world, firms make higher profits

• But if workers are not risk-neutral, they are better off in Rigidland

Theory

EPL as a tax

• Payment to a third party, say a lawyer• Cannot be undone by bonding agreements• Effects on both job creation and destruction as

empoyers anticipate these costs when issuing a vacancy

• In general expected decline in both hiring and separations (flows) with ambiguous effects on employment/unemployment stocks

Theory

Two-tier systems

• Flexibility only at the margin• A “buffer stock” of temporary contracts is

created• This has transient and positive

(“honeymoon”) effects on employment• The effect fades away as permanent

contracts can be fully replaced (e.g. via attrition) by temporary contracts

Theory

Flexi-land

(bad times) (good times)

EmploymentA B

The Honeymoon Effect

Rigid-land


EmploymentA BC


Two-tier Regime


EmploymentA BC D


With Attrition

PRE REFORM POST REFORMTRANSITION

Permanent

Employment in Good Times

Employment in Bad Times

Temporary

Evidence from cross-country studies

Empirical evidence

Exploiting within-country variation

• Wide empirical literature on EPL is only cross-section

• While theory points to institutional interactions (e.g., EPL and wage bargaining) and within-country heterogeneity in coverage (e.g., EPL for regular and temporary employment)

• Need to exploit natural experiments

Empirical evidence

Exploiting within country variable enforcement

• Recent literature exploiting exemptions conditioned on firm size:– Threshold scale below which the most restrictive

regulations are not applied (e.g., Italian firms with less than 15 employees, exempted from art.18 of the Statuto dei Lavoratori)

Empirical evidence

Data: Italy

• Quarterly Labour Force Surveys (1994-6)

• Longitudinal (matched records) and retrospective information (on employment levels and on dismissals): 80,000 individuals

• Size of firms declared by individuals (heaping)

Empirical evidence

Double-difference: temporary vs permanent and above/below 15 employees. Boeri-Jimeno (2004)

Endogeneity of EPL

• Enforcement of EPL is found to be correlated with unemployment

• Generally judges more protective of workers in depressed labor markets

• Part of the effects of EPL on employment/unemployment may capture reverse causality

Empirical evidence

How much protection should EPL provide?

• Trade-offs in provision. Costs for jobseekers and firms. Costs in terms of moral hazard-productivity. Also benefits:

• (privately) for the worker:– reduce income fluctuations protecting against un-insurable labour

market risk; prevent wage underbidding by outsiders

• (privately) for the firm:– buildup of loyalty, trust and co-operation, induces workers to

invest in specific technologies and reduces their resistance to new technologies (workers do not feel threatened)

• (socially) deterrent to opportunistic behavior:– Internalise to firms costs of bad management

Policy issues

Whom should EPL protect?

• Evidence of strong perceptions of job insecurity in the countries with the strictes EPL

• Why? • Mobbing?• More likely selective of EPL. Protects only

subset of workers concentrating risk on the others.

Policy issues

Why does EPL exist?

• EPL is a strongly redistributive institution. It protects those who already have a job, notably a permanent contract in the formal sector.

• Unemployed individuals and workers with temporary contracts suffer in the presence of strict EPL for permanent contracts. The former experience longer unemployment spells, while the latter are caught in a secondary labor market of temporary contracts.

• Employers suffer a loss in profits in the presence of EPL, notably when they do not succeed in making workers pay (through lower wages) for the costs of providing this insurance.

Policy issues

Timing of the radical reform in Spain

0.4

0.45

0.5

0.55

0.6

0.65

87 88 89 90 91 92 93 94 95 96 97 98 99 00 01

Regular long-term employees / active population

Policy issues

Why does EPL exist?

• Depending on the relative number and/or political power of (1) employees with permanent contracts, (2) the unemployed, (3) workers with temporary contracts, and (4) employers, we should have more or less stringent EPL. Another important factor affecting political support for EPL is the presence of other institutions, such as UBs, that can substitute for EPL in providing insurance against unemployment risk.

Policy issues

Review questions

• What are the main drawbacks of available measures of the strictness of EPL?

• Why is there a non-monotonic relationship between EPL and unemployment?

• Why many two-tier reforms of EPL transitorily increase employment?

• What are the efficiency arguments in favor of employment protection?

• When is EPL neutral with respect to labor market outcomes?

Review questions (cont.)

• Why from an economic standpoint is it important to disentangle the transfer from the tax component of EPL?

• Why has empirical work failed to observe the negative relationship between EPL and job and labor turnover predicted by economic theory?

• Why do workers in countries with strict EPL feel less secure than workers in flexible labor markets?

• Why are third parties (e.g., judges) always involved in the enforcement of EPL?

Practicing with real dataPracticing with real data

• Box 10.3:The effects of employment protection:

learning from variable enforcement (pag. 213-

214).• A Stata data file with the Boeri and Jimeno

(2005) dataset, a do file and a log file are available at the website:

http://www.frdb.org/images/customer/boeri.zip

Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.

http://www.frdb.org/images/customer/boeri.zip

Documents

Employment Protection Legislation. What are we talking about? Set of norms and procedures followed in case of dismissal of redundant workers. Act as deterrent: