Two Tier Reforms of Employment Protection: A Honeymoon Effect?

Abstract

Labour market reforms increasing flexibility ‘at the margin’ have been recently paying out in terms of employment growth. This article argues that two‐tier labour market reforms have a transitional ‘honeymoon’, job creating effect. In a dynamic model of labour demand under uncertainty, the article predicts that in the aftermath of reforms, beyond an increase in employment, there should be a reduction in ‘employment inaction’ and in the mean and cross‐sectional variance of labour productivity. Based on a variety of firm‐level data on Italy in the period 1995–2000, we find evidence of our empirical implications.

The Effect of Employment Protection on Labor Productivity

“…With this study I am able to use within country variation to try to establish a causal effect of employment protection on productivity and I contribute to a field where there is so far a limited number of empirical studies (Autor et al 2007, Boeri & Garibaldi 2007. The result that labor productivity increases with increasing labor market flexibility stand in contrast to previous studies.…”

“…A problem inherent in crosscountry studies is the comparability of legislations across countries (OECD 2004). Only two previous studies use variation within a country to try to establish a causal effect of employment protection on labor productivity (Autor et al 2007, Boeri & Garibaldi 2007.…”

Uncertainty and the Politics of Employment Protection

“…28 In this respect, the model is different from a matching model with search frictionsà la Mortensen and Pissarides, where both sides of the market have to wait for a trading partner. See Coles and Petrongolo (2008) for a comparative discussion between different classes of models of job creation.…”

“…There are no search frictions, and therefore firms fill their vacancy instantaneously. 28 The productivity x of each firm is normalized to one at the moment when the firm is created, but it varies over time due to the realization of two independent types of random idiosyncratic shocks. Specifically, x follows a Geometric Brownian process, whose stochastic differential is represented by…”

“…During the same period, the structure of the labor markets of the U.K. and particularly of the U.S. has instead changed relatively little, displaying over time a remarkably persistent, flexible regulation of labor relation. 4 Part of the institutional inertia observed seemed to be related to the fact that many European Governments have implemented simultaneously two antithetical policy measures: on one side they kept or sometimes even reinforced already strong protection policies to reduce job destruction; on the other hand they introduced new flexible, fixed-term contracts, to push job creation (Cahuc and Postel-Vinay, 2002; Boeri and Garibaldi, 2007).…”