significant differences across groups. Montenegro and Pages (2004) find that higher protection in Chile is associated with lower employment rates among young workers, women, and unskilled workers. Marquez (1998) finds that more stringent regulation coincides with a larger percentage of self employed workers, a finding confirmed by Maloney (2001), although the estimated impact was small compared to other education, productivity, or demographic variables.

# **_Theoretically, restrictions should reduce productivity growth although at present the evidence is_**

**_sketchy:_** The literature on the impact on productivity growth is thin at the international level and thinner still in Latin America. Hopenhayn and Rogerson (1993), using a general equilibrium model for job creation and destruction, find that policies that interfere with the natural process of job creation/destruction at the firm level are quite costly in terms of average productivity and, more generally, in terms of aggregate welfare.<sup>14</sup> Parente and Prescott (1991, 2000) argue that TFP differences dominant differences in per capita GDP and that firing costs are one of the policies that increase the power of inside labor in a number of industries to resist changes in work practices and adoption of new technologies. Capelli (2000) and Hobjin and Jovanovic (2001-HJ) also show that stringent hiring and firing restrictions raise the cost of labor adjustments, which is often required after innovation occurs. A more recent analysis provided by Scarpetta and Tressel (2004), using firm OECD data, finds an impact of firing regulations on productivity and technological _via_ its impact on the incentives to innovate and to adopt new technologies.<sup>15</sup> For Latin America, the results are very preliminary: Forthcoming research by Gracia and Santamaría (2004) find that at the aggregate level (national TFP), the substantial reduction of firing costs that occurred in 1990 in Colombia had a positive effect on the evolution of productivity growth. There is also a yet unexplored potential that poorly designed legislation discourages micro and small enterprises from participating in other formal institutions (e.g., credit, training) and thus capitalize on scale economies and innovation.

# **Further Work**

- **<u>Identifying the true costs of job protection.</u>** Many of the findings above prove unstable or at the very least are probably not good guides on the true magnitudes of the impact of employment protections.  In particular, though an important literature stresses the productivity implications of legislation, to date documentation of these effects has been difficult.

> 14 In effect, HR find that a tax on dismissals equal to one year’s wages reduces average productivity by 2%. Consumption, on the other hand, is reduced by about 2.5% (these are long run-equilibrium effects). They find that the tax on job destruction creates a distortion that encourages firms to use resources less efficiently, with the result that productivity drops and fewer resources are devoted to the market sector of the economy. Being more specific, HR find that the channel through effect relates to the fact that when no dismissal costs are present, firms make their employment decisions based solely on the value of the marginal product of labor and the size and sign of the idiosyncratic shocks faced by the firm. However, when such costs are introduced, firms also base their employment decisions on the amount of labor used on previous periods, distorting such decision and making the aggregate marginal product of labor deviate from its equilibrium value. An important point is that in these base calculations, in which the tax on dismissals is set at 20% of the wage, the total costs of such tax are small (about 5% of the payroll), and even then the productivity effects are large. Thus, the authors stress the importance of these distortions and claim that focusing only on their employment effects is a mistake.

> 15 They mention three channels through which it is possible to observe the influence of legislation on innovation: (i) the system of industrial relations; (ii) the cost of hiring and firing workers; and (iii) the possible interactions between industry-specific technological characteristics and employment protection legislation, which lead to different human resources strategies.

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