provide them an incentive to turn informal as well. Generally, enforcement of the regulation is the crucial factor, not the extent of regulation itself.

The adverse effect of rigid regulation on incentive for operating formal has been largely documented in empirical literature, as has been summarized above. Johnson et al. (1997, 1998a, 1998b) present an empirical evidence of significant positive effect of overall regulation on shadow economy. Loayza et al. (2005) reach a similar conclusion as regards the effect of regulation on shadow economy. The study utilizes several measures of regulation and shows a positive effect of each of them including labor regulations.

We follow the OECD methodology (2004) for measuring the strictness of employment protection.<sup>21</sup> Data for old European countries and NMS-4 (Czech Republic, Poland, Slovakia and Hungary) are available from OECD in longer time series. Data for the rest of NMS group except Malta and Cyprus come from IZA database and were available for years 1999, 2003 and 2007 only. Therefore, NMS average in the following paragraph and Annex 2 refers to above mentioned four countries only for sake of comparability of development in time. Overall situation in European countries is shown in Annex 2.

The most liberal hiring and firing conditions were recorded in Denmark, Hungary, Ireland and Slovak Republic in period 2000-2007. France, Greece, Portugal and Spain found themselves on the opposite side of the spectrum. Southern European countries have the toughest regulation while the rules are more relaxed as one moves north. The most substantial changes leading to relaxation of employment protection in this period took place in Slovak Republic, Greece, Italy, Austria, and Portugal. On the contrary, Poland, Hungary and Ireland tightened their legislation moderately. Generally, EPL in NMS-4 is not as strict as in the other group―the average EPL index was significantly lower (1.9 in period 2000-2007). Old European countries recorded average EPL index at 2.4 with a decreasing trend in given period. However, if we extend our comparison to other NMS countries not covered in OECD data as well, the situation looks much different. The rest of the NMS group has generally much tougher legislation compared to NMS being OECD members. Taken altogether, NMS10 group has in average comparably rigid employment protection legislation as old European countries (reaching 2.3 for all three years with data available). The toughest legislation was recorded in Lithuania and Slovenia, but the latter mentioned country relaxed its hiring and firing conditions in given period substantially (similarly to Bulgaria). In contrast, Romania exhibited certain tightening of its employment protection during the examined period.

# _<u>Minimum wages</u>_

Economic theorists have not reached a broad consensus regarding the consequences of the minimum wage so far. Nevertheless, on the microeconomic level it is usually generally accepted that although it might have some positive impact on the motivation to increase productivity among low-paid workers (Stigler, 1946; Acemoglu and Pischke, 1998; Cahuc and Michell, 1996), on shifting the employment composition toward high-wage jobs (Acemoglu, 2001), as a motivational device in the efficient wages framework (Rebitzer and Taylor, 1995; Manning, 1995), or in the case of a monopsony (Card and Krueger, 1995), there

> 21 The OECD developed a system of indicators, including a single overall composite indicator. As many as twenty two measures describing various aspects of EPL, covering regular and temporary contracts and collective dismissals, were aggregated into a summary indicator using a set of weights. The resulting EPL index 2 covers conditions of regular and temporary contracts, and terms of collective dismissals. Indices reach the values from 1 to 6, low index indicates flexible legislation and liberal hiring and firing environment, while stricter protection is reflected in a higher value of the index.

12