Effective Labor Regulation and Microeconomic Flexibility

30 Pages Posted: 25 Aug 2004 Last revised: 2 Mar 2011

See all articles by Ricardo J. Caballero

Ricardo J. Caballero

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Eduardo M. R. A. Engel

Yale University - Department of Economics; National Bureau of Economic Research (NBER)

Kevin Cowan

Adolfo Ibanez University

Alejandro Micco

University of Chile

Multiple version iconThere are 2 versions of this paper

Date Written: June 8, 2010

Abstract

Microeconomic flexibility is at the core of economic growth in modern market economies because it facilitates the process of creative-destruction, The main reason why this process is not infinitely fast, is the presence of adjustment costs, some of them technological, others institutional. Chief among the latter is labor market regulation. While few economists object to the hypothesis that labor market regulation hinders the process of creative-destruction, its empirical support is limited. In this paper we revisit this hypothesis, using a new sectoral panel for 60 countries and a methodology suitable for such a panel. We find that job security regulation clearly hampers the creative-destruction process, especially in countries where regulations are likely to be enforced. Moving from the 20th to the 80th percentile in job security, in countries with strong rule of law, cuts the annual speed of adjustment to shocks by a third while shaving off about one percent from annual productivity growth. The same movement has negligible effects in countries with weak rule of law.

Keywords: Microeconomic rigidities, Creative-destruction, Job security regulation, Adjustment costs, Rule of law

JEL Classification: E24, J23, J63, J64, K00

Suggested Citation

Caballero, Ricardo J. and Engel, Eduardo M. and Cowan, Kevin and Micco, Alejandro, Effective Labor Regulation and Microeconomic Flexibility (June 8, 2010). Cowles Foundation Discussion Paper No. 1480; MIT Department of Economics Working Paper No. 04-30; Yale University Economic Growth Center Discussion Paper No. 893; FRB of Boston Working Paper No. 04-6. Available at SSRN: https://ssrn.com/abstract=581021 or http://dx.doi.org/10.2139/ssrn.581021

Ricardo J. Caballero (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Eduardo M. Engel

Yale University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Kevin Cowan

Adolfo Ibanez University ( email )

Santiago
Chile

Alejandro Micco

University of Chile ( email )

Pío Nono Nº1, Providencia
Santiago, R. Metropolitana 7520421
Chile

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