Labor Retrenchment Laws and Their Effect on Wages and Employment: A Theoretical Investigation

37 Pages Posted: 26 Apr 2007

See all articles by Kaushik Basu

Kaushik Basu

Cornell University - Department of Economics; IZA Institute of Labor Economics; Brookings Institution

Gary Fields

Cornell University - School of Industrial and Labor Relations; National Bureau of Economic Research (NBER); IZA Institute of Labor Economics

Shub Debgupta

PricewaterhouseCoopers, LLP

Date Written: April 2007

Abstract

Many countries have legislation which make it costly for firms to dismiss or retrench workers. In the case of India, the Industrial Disputes Act, 1947, requires firms that employ 50 or more workers to pay a compensation to any worker who is to be retrenched. This paper builds a theoretical model to analyze the effects of such anti-retrenchment laws. Our model reveals that an anti-retrenchment law can cause wages and employment to rise or fall, depending on the parametric conditions prevailing in the market. We then use this simple model to isolate conditions under which an anti-retrenchment law raises wages and employment. In a subsequent section we assume that the law specifies exogenously the amount of compensation, s, a firm has to pay each worker who is being dismissed. It is then shown that as s rises, starting from zero, equilibrium wages fall. However beyond a certain point, further rises in s cause wages to rise. In other words, the relation between the exogenously specified cost to the firm of dismissing a worker and the equilibrium wage is V-shaped.

Keywords: labor laws, retrenchment, severance pay, unemployment

JEL Classification: O15, O17, J32, J63

Suggested Citation

Basu, Kaushik and Fields, Gary S. and Debgupta, Shub, Labor Retrenchment Laws and Their Effect on Wages and Employment: A Theoretical Investigation (April 2007). IZA Discussion Paper No. 2742. Available at SSRN: https://ssrn.com/abstract=982163

Kaushik Basu (Contact Author)

Cornell University - Department of Economics ( email )

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IZA Institute of Labor Economics

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Brookings Institution ( email )

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Gary S. Fields

Cornell University - School of Industrial and Labor Relations ( email )

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National Bureau of Economic Research (NBER)

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IZA Institute of Labor Economics

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Shub Debgupta

PricewaterhouseCoopers, LLP

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New York, NY 10019
United States

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