Literature Review: The Economic Impacts of Employment Protection Laws

Over the last 50 years, many jurisdictions have seen increases in the level of employment protection law. At first glance one might assume that wrongful discharge laws and other forms of employment protection are good for workers. Theoretical work is ambiguous however, and empirical studies have found more sinister results. In many cases, by increasing the costs of letting workers go, employers become more reluctant to make new hires. This is shown in a variety of times and places, through various means. Additional work is needed, however, in both the theory and empirics of employment protection law literature. For most of recent history in the United States and western Europe, the relationship between employer and employee went mostly unregulated. Workers and owners were assumed to each have equal bargaining power over the contracting of labor. Workers were free to leave a job while owners were free to fire laborers as they each saw fit. In an era of artisanal, high-skilled work, this arrangement made sense. Owners provided workers with job security not out of the kindness of their heart, but because training new workers in high-skill and small-scale production was prohibitively costly. This doctrine, known as employment-at-will (the will of either employee or owner to end the relationship) was carved into American case law in Payne vs. Western and Atlantic Railroad (1884) The Tennessee Supreme court ruled that firing for any reason was legal, famously stating that “All [employers] may dismiss their employees at will, be they many or few, for good cause, for bad cause, or even for cause morally wrong, without hereby being guilty of a legal wrong”. By and large, the pre-industrial experience was the same in Europe. With the growth of industry in the 19 and early 20 century, however, the relationship between employee and owner changed. As businesses increased in scale, workers became increasingly specialized in their labor. Work became simplified and more repetitive, and the nature of job protection changed. Workers became substitutable, as less firm-specific human capital was required to perform a given task. At the same time, training new workers required fewer resources. These effects combined to drastically damage job security. As a result, a number of countervailing employment protection measures found their way into the American job market. [Although not directly applicable to employment protection laws, it is worth noting the rise trade unions in the United States; over the first half of the 20 century, union membership increased dramatically along with the industrialization of the economy. In many ways, unions achieved a leveling of the playing field by increasing job security as 1 A common misconception, Payne was actually not an employee of Western & Atlantic Railroad. Rather, he was a merchant who sued the railroad for adopting a policy of dismissal for anyone “who trades with L. Payne” (Hogler, 1989). Claiming the policy ruined his business, the court nonetheless ruled that the railroad had the right to fire no matter the cause. well as increasing bargaining power of workers through collective bargaining. ] If pre-World War II employment protection could be attributed to the growth of unions, it must be recognized that union membership has largely receded in the postwar period. Instead, employment protection has been gained through court fiat and legislative action. Collectively, these actions constitute the literature on employment protection laws. Employment protection legislation (EPL), generally speaking, provides job security to those working. Counterintuitively, however, the laws are generally found to reduce aggregate employment. The overall effect on welfare then is ambiguous, and this is possibly the largest question the current literature hopes to answer. This paper is going to review three major avenues of employment protection laws (EPLs for short), and the economic effects of such laws. First, however, some of the theoretical underpinnings used commonly will be presented. Then, the paper will discuss EPLs in the United States, focusing on impacts in the post-war period. Third, the paper will discuss EPL in the European Union (EU). Lastly, the paper will return to the United States to review the Americans with Disabilities Act (ADA). The paper will close with some thoughts on the future of EPL research; where more research is needed and some interesting (current) extensions to the literature. I.Theoretical impacts of employment protection laws Lazear (1990) is perhaps the most commonly cited paper in the theoretically modeling the effects of EPL, and is one of the earliest papers doing so. Lazear considers a 2 period model where a contract is signed in period 1 and work is performed in period 2. Without any constraints, the wage will settle at some market-clearing wage W*. If a severance pay Q is mandated in the case that the worker is let go before working in period 2 (this event occurs with probability P), then it is necessarily the case that the worker earns