Effective Labor Regulation and Microeconomic Flexibility

34 Pages Posted: 23 Sep 2004 Last revised: 10 Oct 2004

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: September 2004

Abstract

Microeconomic flexibility, by facilitating the process of creative-destruction, is at the core of economic growth in modern market economies. The main reason for why this process is not infinitely fast, is the presence of adjustment costs, some of them technological, other institutional. Chief among the latter is labor market regulation. While few economists would object to such a view, its empirical support is rather weak. In this paper we revisit this hypothesis and find strong evidence for it. We use 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.

Suggested Citation

Caballero, Ricardo J. and Engel, Eduardo M. and Cowan, Kevin and Micco, Alejandro, Effective Labor Regulation and Microeconomic Flexibility (September 2004). NBER Working Paper No. w10744. Available at SSRN: https://ssrn.com/abstract=590734

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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