The Joint Design of Unemployment Insurance and Employment Protection: A First Pass

Abstract

Unemployment insurance and employment protection are typically discussed and studied in isolation. In this paper, we argue that they are tightly linked, and we focus on their joint optimal design.

We start our analysis with a simple benchmark, with risk averse workers, risk neutral firms, and random shocks to productivity. In this benchmark, we show that unemployment insurance comes with employment protection - in the form of layoff taxes; indeed, optimality requires that layoff taxes be equal to unemployment benefits.

We then explore the implications of four broad categories of deviations: limits on insurance, limits on layoff taxes, ex-post wage bargaining, and ex-ante heterogeneity of firms or workers. We show how the design must be modified in each case. The scope for insurance may be more limited than in the benchmark; so may the scope for employment protection. The general principle remains however, namely the need to look at unemployment insurance and employment protection together, rather than in isolation.

Keywords: Unemployment insurance, employment protection, unemployment benefits, layoff taxes, layoffs, severance payments

JEL Classification: D60, E62, H21, J30, J32, J38, J65