In the next step, this variable is regressed on: 1) country specific and industry specific fixed effects; and 2) time dummies that are country and industry specific. The predicted value is used as a measure of human capital in the MFP regressions reported in the main text.<sup>12</sup> Given the discussion in the previous section, we consider two main indicators of policy and institutions: i) an indicator of hiring and firing costs; and ii) an indicator of the industrial relations regime in each country. Hiring and firing costs are proxied by the indicator of the stringency of employment protection legislation ( _EPL_ ). The EPL indicator refers to nation-wide regulations and laws and thus does not vary across industries in a given country, even if the related hiring and firing costs may well differ depending on specific characteristics of each industry (see Box 1). We have also used a measure of EPL that interacts with the size of firms in each industry. Since the average size of firms in a given industry is likely to be endogenous to market conditions, including institutional factors, we have used the cross-country firm size average for each industry (across a sample of ten OECD countries) and applied it to all countries. Industrial relations regimes are identified by a summary indicator of _corporatism_ as discussed above. Moreover, we also test for different patterns of productivity growth depending on technology regimes by dividing the industry sample into two main groups: low-tech and high tech industries (see Box 1).

# **Box 1. Indicators of Employment Protection, Wage Bargaining and Technological Groups The indicators of employment protection legislation (EPL)**

The indicators of employment protection legislation are available for two periods (late 1980s and 1998) and focus on both regular and temporary contracts (see Nicoletti _et al._ 1999). Regulations for regular contracts include: i) procedural inconvenience that employers face when trying to dismiss a worker; ii) advance notice of the dismissal and severance payments; and iii) prevailing standards of, and penalties for, “unfair” dismissals. Indicators of the stringency of EPL for temporary contracts include: i) the “objective” reasons under which they can be offered; ii) the maximum number of successive renewals; and iii) the maximum cumulated duration of the contract. The EPL indicator used in the econometric analysis is time-varying, with the shift in regime from the late 1980s stance to that of 1990s being defined on the basis of information about the timing of major EPL reforms (concerning both temporary and regular workers) in OECD countries. It should be stressed that the EPL indicators are constructed on the basis of differences in regulatory settings across OECD countries. The focus is on excessive regulation that could unnecessarily restrict market mechanisms, because it makes reallocation of resources difficult, hindering the response of the economy to structural changes.

The indicator of EPL interacting with industry firm size uses the cross-country average size of firms in each industry to minimize possible endogeneity of the firm dimension to regulations. The cross-country average of firm size in each industry is calculated using a sample of 9 OECD countries. For each country, data are from the business register or the social security administration and cover all firms with one or more employees. See Bartelsman _et al._ (2003) for details.

continued 12 . The coefficient on human capital remains significant with the same sign if the original variable is used instead of the predicted one in the productivity regressions. The use of the original variable, however, reduces somewhat the sample size, and thus we decided to concentrate on the predicted human capital variable.

11