unions had veto power over dismissals for staff reductions or for employees not suited to the job (See World Bank (2003)). Before the 1999 reform in Brazil, representatives of employers and workers sat on the jury of labor courts, a practice that often led to protracted procedures and difficulties in reaching compromise. Because of the complexity of the severance pay schemes, more than 6 percent of all salaried workers (about 2 million) usually filed a lawsuit every year and the average labor dispute took almost three years. The reform restricted the jury to professional lawyers and cut the time to resolve a dispute by half (World Bank, 2002).

_How employers react to employment protection_ The effects of EPL on firms’ behavior are likely to be mediated by several factors. As discussed above, stringent EPL would not constrain firm performance and job creation if workers fully valued the benefits of employment protection and were willing to trade them off for greater effort or a lower monetary compensation.<sup>4</sup> But if the costs associated with stringent EPL are too high to be fully transferred into lower wages or higher productivity, or if workers’ organization resist wage reductions, then they may lead to lower job creation and possibly lower investment in new technologies.

_Temporary versus regular workers._ When employment protection legislation is less stringent than legislation for regular workers, firms may be encouraged to hire more workers on a temporary basis to increase workforce flexibility. Indeed many countries around the world have liberalized temporary contracts in the past decade – expanding the list of jobs allowed under temporary contracts, lengthening their maximum duration and/or allowing temporary work agencies to operate. Evidence from France, Spain, Argentina, Peru, and Colombia suggests that the asymmetric liberalization of temporary contracts, while leaving in place strict regulations for regular contracts, has led to significant shifts of labor demand in favor of temporary employment. In Spain temporary employment reached almost one-third of the total workforce after the reform of temporary contracts in the mid-1980s. In Peru, the liberalization of temporary employment in the early 1990s led to an increase in temporary employment from 20 percent in 1990 to 55 percent in 2000. In Colombia there was a similar large increase and in South Africa more than 90 percent of large firms are reported to make greater use of temporary workers to increase flexibility of the workforce. Interestingly, while about one-third of formal micro-enterprises in South Africa use temporary employment, the share is less than 10 percent among informal firms (Chandra and others, 2001).

Liberalizing temporary contracts, while leaving in place strict regulations on regular contracts tends to reinforce the inequality in the labor market (see OECD, 2004). Firms will have stronger incentives to hire more workers at the entry level and employ them for a limited period, without giving them a regular position thereafter. This increases job turnover but not necessarily overall employment or productivity, because the additional hires will be accompanied by additional layoffs at the end of the temporary contracts, and

> 4 Labor protection provisions can be justified on the grounds that workers are risk averse and that they do not have the possibility to privately insure themselves against labor market uncertainty or prefer to trade off lower earnings for better working conditions. See Bertola (2004).

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