sou · GYB393 · 2011-01-01 00:00:00 — If just cause is imposed from outside, wages would be lowered to compensate for the higher job security and the wage decrease would be worth less to the workers than the employment security. Thus, imposition of just cause policies will not help workers, but will merely reduce the surplus from the worker-firm relationship. This reasoning is valid when labor markets are perfectly competitive. When labor markets are perfectly competitive, employers compete to attract workers and the competition between firms allows the workers to benefit from the best combinations of wages and working conditions available in the economy. In this context, the employment at-will doctrine grants perfect protection to employees and there is no need for further employment protection legislation. However, labor markets are not perfectly competitive. Mobility costs, imperfect information, myopic behaviors, contract incompleteness, do not allow workers to fully benefit from competition between firms. When market are not perfectly competitive, employment protection legislation can be useful to protect workers against the arbitrary decisions of employers. For instance, an employer who does not comply with health and safety regulations in the workplace may fire workers who complain. The employer may have an interest to do so if he has monopsony power which allows him to replace those workers Bilaga 6 till LU2011 The benefits of job protection at low cost. Enacting a regulation which protects workers against such layoffs may improve efficiency. However, even if there are justifications for just cause, job protection legislations should be elaborated cautiously because they can have perverse effects. For instance, Acemoglu and Angrist (2001) have studied the consequences of the Americans with Disabilities Act, which requires employers to accommodate disabled workers and outlaws discrimination against the disabled in hiring, firing, and pay. Although the Americans with Disabilities Act was meant to increase the employment of the disabled, the net theoretical effects are ambiguous, because employers have may ways to avoid recruiting disabled employees. Actually, it seems that the Americans with Disabilities Act has had an effect exactly opposite to its goal: for men of all working ages and women under 40, Acemoglu and Angrist find a sharp drop in the employment of disabled workers after the Americans with Disabilities Act went into effect. Another example is given by Wasmer (2006) who finds, using Canadian data including details on work-related stress and the consumption of various medications, that harassing workers in order to induce a quit appears to be a substitute for greater dismissal freedom. Wasmer finds positive links between individual employment protection and some dimensions of stress, and positive links between the stringency of employment protection, depression and the consumption of various psychotropic drugs. It should be noted that the benefits of job protection are generally unevenly distributed and can deteriorate the well-being of workers who do not benefit from job protection. In particular, temporary workers are generally disadvantaged by protection of permanent jobs, because employers are more reluctant to transform temporary jobs into permanent jobs when it is more costly to fire permanent workers. Therefore, a stronger protection of permanent workers may help permanent workers to keep their job, but at the expense of the unemployed and temporary workers whose opportunities to get stable jobs are reduced by this form of job protection. This mechanism explains why insiders, who occupy permanent jobs, can sustain stringent employment protection legislation at the expense of the outsiders, who do not occupy permanent jobs. The youth, the less skilled workers and the immigrants are those who are the most frequently outsiders. The skilled prime age males typically belong to the group of insiders. The benefits of job protection Bilaga 6 till LU2011 The just cause doctrine, which aims at protecting workers against arbitrary dismissals, justifies some aspects of the Swedish employment protection legislation, such as controls by the courts and the existence of mandatory notice, which allows the employees to organize their defense. However, the last-in first-out rule, which defines the order of selection for dismissals, can be justified by the protection of workers from arbitrary dismissals. Actually, the last-in first-out rule emerges as the consequence of the strong relative power of insiders with the highest seniority, who are able to impose such a rule at the expense of other workers. As a matter of fact, the last-in first-out rule is often circumvented by agreements between the union and the firm. This fact makes the rules less stringent, but also strengthens the power of the union. Importantly, the last-in first-out rule, is the fallback if no agreement can be made. These features allow the insiders to protect their jobs at the expenses of the outsiders. In the same vein, the rehiring priority of dismissed workers and the principle that no just cause for dismissal exists if the employer can reasonably be required to find the employee concerned alternative work within the company, which benefit the insiders, can also be justified by the protection of workers from arbitrary decisions of employers. 3.2The internalization of social costs of labor turnover Modern economies are subjected to a permanent flux of technological innovations and changes in the preferences of individuals, necessitating the disappearance of some jobs and the creation of others. This incessant process of job creation and destruction contributes to growth. When a job vanishes for these reasons, it is thus not a loss for the collectivity, although it generally is for the person who held that job. Legislation that prevented the destruction would by the same token have prevented a collective advantage from being realized. But conversely there are other reasons that weigh in favor of preserving certain jobs which firms might want to destroy. They spring from the difference between the private value and the social value of a job. A worker is engaged by a firm to produce goods or services. This production represents the private value of the job, and is split Bilaga 6 till LU2011 The benefits of job protection between a wage for the worker and profit for the firm. But in a modern economy a firm and its workers are not insulated from the rest of the world, and the decisions they take affect the well-being of other persons who have nothing to do with the firm. This influence of the decisions of some persons on what happens to others who are extraneous to the taking of the decision is called an externality; pollution is a well-known example. Now the decision to destroy a job can have repercussions going well beyond the interests of the firm and the worker alone. It can also be a source of externalities. In this case, the value of a job for the collectivity (its social value) does not coincide with its private value. The social value is measured by the sum of the private value plus the value of the externalities. One important cause of the gap between the social value and the private value of a job lies in the overall of the fiscal system. The largest portion by far of receipts to the fiscal system comes from persons who hold jobs. Unemployed and inactive persons contribute very to the financing of collective goods and transfers. It follows that there is a gap between the social and the private value of a job, measured by the loss of compulsory payroll taxes, and by extra costs in the form of social transfers that are triggered when someone moves from the status of wage-earner to that of unemployed or inactive person. In most countries this difference is considerable, and justifies a form of employment protection. The mode in which unemployment insurance and all forms of welfare are financed is another cause, perhaps more important than the previous one, of a divergence between the social and the private value of a job. In most industrialized countries, unemployment insurance is financed by a tax based on wages, which is paid in varying proportions by both employees and employers; it is one component of what are collectively called payroll taxes. Under an efficient system of unemployment insurance, an employer who lets an employee go would have to take into account the externality arising from the financing of the unemployment insurance benefit then paid to that worker by other wage-earners and other employers through their contributions to unemployment insurance. Under an efficient unemployment insurance system, the employer would also have to take into account the fact that the job she has destroyed will no longer contribute to financing the system. Absent such efficiency, every firm relies on all the other The benefits of job protection Bilaga 6 till LU2011 firms and wage-earners to pay the unemployment benefits of the workers it lets go. The social value of a job exceeds its private value by an amount equal to the cost for society of the person laid off while he is unemployed. In neglecting the externalities occasioned by their behavior when they let someone go, firms are reckoning only the private cost to themselves, not the real cost of this separation to society. In situations in which this real cost exceeds the individual cost to the firm, firms will have a tendency to destroy too many jobs. The distortions induced by compulsory payroll taxes are not the only reasons for a gap between the social value and the private value of employment. Unemployment exerts a negative effect on one's state of health, and it can increase criminality and undermine civic spirit (Fougère et al. As well, persons who have jobs frequently redistribute a part of their material resources to their families and to those close to them. employment contributes to ameliorating the general state of health and reducing criminality; it forms part of a web of social bonds which ensure a certain redistribution of resources. All these factors should be taken into account in judging the collective advantage resulting from decisions about job destruction. Absent a set of rules making it costly to fire, a firm that decides to separate from one of its employees takes account only of the private value of the job it is destroying; it estimates that this private value is too low to make the job worth . But this layoff generates externalities such that the social value is higher than the private value. So the firm makes a decision efficient from its own point of view, but which does not conform to the collective interest. The state must then intervene in order to realign the interest of the firm with that of the collectivity. In the last analysis, a policy of protecting employment can be justified by the goal of achieving this realignment. This justification of job protection implies that job protection should be stronger in countries where the welfare state is more generous, because the costs of unemployment are more mutualized when unemployment benefits, health insurance and taxes are higher. Therefore, the difference between the social and the private value of a job is larger when the welfare state is larger. Cultural aspects can also play a role. In cultures with strong family ties or strong local social capital, moving away from home is costly. Thus, individuals with strong family ties prefer regulated labor markets to avoid moving, Bilaga 6 till LU2011 The benefits of job protection even though regulation generates lower employment and income. Accordingly, countries with stronger family ties or stronger local social capital may rationally choose more stringent job protection legislation in order to avoid geographical mobility that may erode family ties and local social relations. 4 The costs of job protection Recent research on the consequences of employment protection has found that the stringency of regulations has a negative impact on employment for some groups of workers (notably youth), increases unemployment duration, productivity and innovations, and encourages labor market segmentation. Legislation making layoffs more difficult has an ambiguous effect on the volume of employment. It certainly cuts back on job destruction, but it also diminishes job creation, since firms fear being unable, in the future, to destroy unprofitable jobs protected by the legislation. Employment protection is therefore favorable to employment if it reduces job destruction more than it does job creation. precisely, protection of permanent jobs has ambiguous effects on employment and permanent employment: on the one hand, more stringent protection reduces creation of permanent jobs because it increases the cost of offering permanent jobs; on the other hand, more stringent protection makes it more difficult to fire workers from permanent jobs, increasing employment and the relative incidence of permanent jobs. Also, making it more difficult to create temporary jobs reduces their relative incidence but has ambiguous effects on overall employment. The ambiguity is due to the opposing factors of the higher cost of offering jobs on the one hand and a lower exit rate from employment on the other hand. Theoretical analysis gets us this far and no farther. So assessment of the impact of employment protection remains primarily an empirical question. Much research has tackled this problem since the 1990s. As a general rule, it tries to show a The costs of job protection Bilaga 6 till LU2011 correlation, positive or negative, between the "rigor" of employment protection and the rate of unemployment, taking care to bracket all the other forces that might affect unemployment and employment. Empirical studies of the impact of employment protection on unemployment and employment can be classified in two groups. A first group of contributions analyze cross-country correlations between unemployment and various indicators of employment protection legislation. The contributions of Lazear (1990), Nickell and Layard (1999), and Wolfers (2000), and Texeira (2003), Botero et al. (2004) among others analyze this type of correlation. They generally find positive correlations between employment protection and unemployment. However, these results should be interpreted cautiously because changes in employment protection legislation and changes in unemployment can be co-determined by common factors. For instance, it is possible that negative macroeconomic shocks, which increase unemployment, also lead insiders to demand more job protection. Then, positive correlations between job protection and unemployment do not reflect the positive impact of job protection on unemployment, but the common impact of macroeconomic shocks on unemployment and employment protection legislations. A second group of contributions at the level of the industry, or at the level of the firm, or at the individual level, allows for better identifications of the impact of labor market regulations on employment outcomes. In some cases, reforms of employment protection legislations were targeted at subgroups in the labor force, providing researchers with a natural experiment in which outcomes can be compared across subgroups. These studies find negative effects of job protection on employment and labor flows. For instance, Autor et al. (2006) estimate the effects on employment and wages of wrongful discharge protections adopted by U.S. state courts during the last three decades. They find that wrongful discharge protections reduced state employment rates by 0.8 percent to 1.7 percent. The initial impact is largest for female and less-educated workers, while the longer-term effect is greater for older and more-educated workers. Using manufacturing data for , Ashan and Pages (2009) study the economic effects of legal amendments on two types of labor laws: employment protection and labor dispute resolution legislation. They find that laws that increase employment protection or the cost of labor Bilaga 6 till LU2011 The costs of job protection disputes substantially reduce registered sector employment and output. and Carneiro (2009) find that stricter enforcement of labor regulations constrains firm size and reduces the use of informal labor in . Micco and Pagés (2006) examine manufacturing data for a number of developed and developing countries and find that employment protection legislation constrains output and employment growth. The Spanish reforms of 1997, which reduced dismissal costs for permanent jobs for workers under and for those over but not for those 30–44, were associated with a relative increase in permanent employment for these groups (Kugler et al., 2005). Similarly, in in 1990, dismissal costs were lowered for jobs in the formal sector but not for the informal sector. This was associated with higher labor market turnover into and out of unemployment in the formal sector relative to the informal sector (Kugler, 1999). Increasing employment protection in the UK in 1999 lowered the probation period during which workers may not sue for unfair dismissal from two years to one year. This was associated with a decrease in the firing hazard for workers with up to two years of tenure relative to those with more tenure (Marinescu, 2007). The Italian reform of 1990 raising dismissal costs for firms with fewer than 15 workers was associated with reduced accessions and separations for these firms relative to larger firms (Kugler and Pica, 2008). Besley and Burgess (2004) isolate the effect of a labor reform in a given state in . They find labor regulations to have important adverse effects on output and employment, particularly in the registered manufacturing sector. To summarize: the principal conclusions arrived at by the empirical research on the impact of employment protection legislation on unemployment are as follows: The rigor of employment protection has no significant effect on the rate of unemployment. more rigorous employment protection does not help to reduce the rate of unemployment. rigorous employment protection increases the duration of unemployment. Empirical studies, which rely on disaggregated data, find that more rigorous employment protection reduces employment. The costs of job protection Bilaga 6 till LU2011 From a theoretical point of view, job protection has ambiguous effects on productivity. protection may induce workers to invest more in specific skills and to put more effort into cooperation within the firm because they anticipate that their long employment spell will allow them to get the returns of such investments (Wasmer, 2006a, Belot et al. However, it should be stressed there is no need to impose job protection from outside the employment relationship to achieve such goals. Workers and employers can enhance job stability by contractual means, like, for instance, severance payments. It is hard to believe that the legislator is able to do a better job than workers and employers in this dimension. Actually, job protection is likely to decrease productivity for several reasons. First, job protection makes it more difficult for firms to react quickly to rapid changes in technology or product demand that require reallocation of staff or downsizing, slowing the flow of labor resources into emerging high productivity firms, industries or activities (Hopenhayn and Rogerson, 1993). For instance, (2002a) argues that stringent job protection may induce secondary innovations that improve existing products rather than introducing new products, more efficient but also riskier. Bartelsman et al. (2004) suggest that stringent employment protection legislations discourage firms from experimenting with new technologies, with higher mean returns but also higher variance. and Scarpetta (2005) provide some empirical evidence showing that innovative firms are the most negatively affected by stringent employment protection legislation. Second, job protection can reduce productivity by lowering the effort of workers because there is less threat of layoff in response to poor work performance or absenteeism. Ichino and Riphahn (2005) show that the hike in job security at the end of the probation period induces a significant increase in absenteeism for white collar workers in . Similar findings are obtained by Riphahn (2004) using German data. (2009) analyzes the consequences of an exemption in the Swedish Employment Protection Act (LAS) in 2001 which made it possible for employers with a maximum of ten employees to exempt two workers from the seniority rule at times of redundancies. Using this within-country enforcement variation, the relationship Bilaga 6 till LU2011 The costs of job protection between employment protection and sickness absence among employees is examined. The average treatment effect of the exemption is found to decrease sickness absence by more than 13 percent at those that were treated relative to those that were not and this was due to a behavioral, rather than a compositional, effect. The results suggest that the exemption had the largest impact on shorter spells and among with a relatively low share of females or temporary contracts. The empirical literature dealing with the relationship between job protection and productivity can be classified into two types of contributions. First, some contributions rely on aggregate cross-country data. These contributions do not provide clear cut conclusions. DeFreitas and (1998) find that stricter job protection has a negative impact on labor productivity growth in the manufacturing industries of a sample of Latin American and Asian countries. Nickell and Layard (1999) and Koeniger (2005) find weak positive relationships between the stringency of job protection, total factors productivity growth and research and development intensity for countries. These results are difficult to interpret because correlations observed with aggregate cross-country data do not allow us to exhibit a causal impact of employment protection legislation on productivity. A second set of contributions, using data at the industry, at the firm or at the levels provides more conclusive and more convincing results. Autor et al. (2007) study the impact of adoption of wrongful-discharge protection norms by state courts in the using establishment-level data. They find that capital deepening is increased while employment flows, firm entry and productivity are reduced. Similar findings are provided by Cingano et al. (2008) using Italian data to examine a 1990 reform that raised dismissal costs for firms with fewer than 15 employees only. In a study on job protection and job flows, Micco and Pagés (2006) also provide some weak evidence of a relationship between job protection and productivity, using a difference-in-differences estimator on a cross-section of industry level data for several and non-OECD countries. They find a negative relationship between layoff costs and labor productivity. Bassanini et al. (2009) examine the impact of employment protection legislation on productivity in the , using annual cross- country aggregate data on the degree of regulations and industry The costs of job protection Bilaga 6 till LU2011 level data on productivity from 1982 to 2003. They adopt a difference-in-difference framework, which exploits likely differences in the productivity effect of dismissal regulations in different industries. Their identifying assumption is that stricter employment protection influences worker or firm behavior, and thereby productivity, more in industries where the policy is likely to be binding than in other industries.