Do Labor Market Conditions Affect the Strictness of Employment Protection Legislation?
Department of Public Economics, Sapienza - University of Rome
University of Rome I - Department of Public Economics
March 17, 2009
Economics Bulletin, Vol. 10, No. 4, pp. 1-9, March 2008
We provide a theoretical microfoundation for the negative relationship between firing costs and labor market tightness and its effects on labor market performance. The optimal level of firing costs is chosen by the employed worker -- i.e. the insider -- by maximizing her human capital. Performing a comparative statics exercise, we analyze the effects of labor market tightness on the optimal choice of firing costs. The results are clear cut and allow to obtain a decreasing firing costs function in the labor market tightness. Moreover, we show that this negative relationship can give rise to a labor market configuration characterized by multiple equilibria: prolonged average duration of unemployment will produce a labor market with low flows and high strictness of employment protection, and vice versa.
Keywords: Firing Costs, Multiple Equilibria
JEL Classification: J64, J65Accepted Paper Series
Date posted: March 18, 2009
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