The Employment Effects of Severance Payments with Wage Rigidities

47 Pages Posted: 27 Oct 2004

See all articles by Pietro Garibaldi

Pietro Garibaldi

Bocconi University - Department of Economics; Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Giovanni L. Violante

New York University, Department of Economics; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: September 2004

Abstract

Firing costs due to employment protection legislation have two separate dimensions: a transfer from the firm to the worker to be laid off and a tax paid outside the firm-worker pair. We document that, quantitatively, transfers are a much larger component than taxes. Nevertheless, to avoid the 'bonding critique' most of the existing literature overlooks the transfer component by making the implicit assumption that, in the presence of wage rigidity, mandatory severance payments have the same real effects as firing taxes. This Paper shows, in the context of a search model with insider and outsider workers, that this presumption is, in general, misplaced: the impact of severance payments on unemployment is qualitatively different from that of firing taxes, and it varies according to the bite of the wage rigidity. When the wage rigidity is endogenously determined by a centralized monopoly union of insiders, severance payments are either neutral or they increase unemployment, depending on the union's coverage of outsiders' contracts. This prediction finds empirical support in a panel dataset of OECD countries.

Keywords: Firing tax, severance payment, unemployment, wage rigidity

JEL Classification: E24, J64, J65

Suggested Citation

Garibaldi, Pietro and Violante, Giovanni L., The Employment Effects of Severance Payments with Wage Rigidities (September 2004). CEPR Discussion Paper No. 4608. Available at SSRN: https://ssrn.com/abstract=610924

Pietro Garibaldi (Contact Author)

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy
+39 02 5836 5422 (Phone)
+39 02 5836 5343 (Fax)

HOME PAGE: http://www.frdb.org/~pietrogaribaldi/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Giovanni L. Violante

New York University, Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
212-992-9771 (Phone)
212-995-4186 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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