Employment Protection, Flexibility and Economic Outcome Alejandro Micco Stockholm, June 2006

Outline Job and Worker Dynamics Turnover around the World and Sweden Factor Reallocation and Productivity Growth Protecting workers against labor market risks. Employment Protection Laws (EPL), Flexibility and Economic Outcome

Job and Worker Turnover: The Hidden Side of the Labor Market “Although most studies focus on net changes in employment, unemployment, or inactivity, it turns out that relatively small net changes in these variables hide a phenomenal amount of reallocation activity in the labor market.” “Inter-American Development Bank 2004”

There is a huge amount of Job Turnover Employment Dest Job Creat Turnover . + =

…and even more Worker Turnover

Firms’ Annual Employment Growth US Manufacturing Sector 20% increase Davis and Haltiwanger AER(1992). Period 1987-1992

There is the same heterogeneity for productivity a 100% Difference Bernard et al (AER 2003). US manufacturing sector

Firms Heterogeneity Evidence: In each period firms are affected by large shocks. These shocks imply changes on relative productivity and factor adjustment (employment) Firms need factor flexibility to absorb these shocks. Lack of flexibility of one factor increases its costs (relative to the other factors). Reallocation is an important factor in productivity growth. In the U.S. Manufacturing sector, reallocation account for 35-50% of total growth (87-97) Foster, L., J. Haltiwanger y C. Krian (1998)

but While labor reallocation is indeed important to promote productivity growth, it is also painful for the affected workers, who face significant search and other adjustment costs.

Protecting workers against labor market risks. Employment Protection Law Unemployment Insurance Unemployment assistance Employment program / Active Labor Program Policies

Protecting workers against labor market risks. EPL

Employment Laws Index Botero, Djankov, La Porta, Lopez de Silanes and Andrei Shleifer (QJE2003)

Employment Protection Index OECD (2004) OECD (EO 2004)

Employment Protection Laws (theoretical predictions) Insurance Mechanism Does not reduce job search effort Increase incentive to enter U Not always available (bankruptcy/unfunded) Efficiency effect Negative effects Reduce efficient factor reallocation Reduce Speed of labor adjustment, then it increases labor relative cost Reduce the adoption of new technologies Positive effects Increase effort (long term relationship) investment in specific human capital Market Dualism (insiders / outsiders)

Empirical Analyses: EPL and Firms’ ability to react to shocks First Approach: EPL & JT OECD: Employment Outlook (1999)

EPL and Firms’ ability to react to shocks First Approach: EPL & JT Problems Data Few observations (time invariant) Heterogeneous Reallocation is a function of: EPLS Volatility (Shocks SD) Endogeneity of Volatility and EPL Countries that faced more shocks implement EPLs Omitted Variable Problem Differences on Entry Costs, access to credit, development, etc. OECD: Employment Outlook (1999)

Alternative Approach Effective Labor Regulation and Microeconomic Flexibility Caballero, Cowan, Engel and Micco (2003) The Economic Effect of Employment Protection Laws Micco and Pagés (2006)

1.- Effective Labor Regulation and Microeconomic Flexibility Caballero, Cowan, Engel and Micco (2003) Methodology We compute the Speed of Adjustment Employment Gap between the desired and current level of employment (Gap). Speed of adjustment (λ): fraction of this gap that it is closed in a year. We compute this gap for 28 manufacturing sectors in 60 countries during 20 years. We study λ as a function EPL and Rule of Law (RL) We calibrate a model to compute the effect of Speed of adjustment λ on growth Advantages: more observations, de jure and de facto regulation, income level control, etc

Results: EPL and Speed of Adjustment

Results: Results: EPL, Speed of Adjustment and Growth In our calibrated model: Moving from λ=.575 to .675 implies an increase on annual growth of 0.3%. Job Security Speed of Adj Cost in Annual Growth 20th to 40th percentile 0.060 -0.03 0.08% 40th to 60th percentile 0.170 -0.09 0.29% 60th to 80th percentile 0.190 -0.10 0.48% 20th to 80th percentile 0.420 -0.22 0.85% Authors' calculation.

2.- The Economic Effect of Employment Protection Laws Methodology Due to technological and demand reasons Industries have different requirement of flexibility. Eg. Sector 322: Manufacture of wearing apparel requires flexibility Sector 342: Printing does not require much flexibility. Sectors that require more flexibility should be more affected by EPLs. We study how the difference on job turnover, employment level and productivity between sectors that require flexibility and the one who do not change across countries with different EPLs. Data: Job turnover 20 countries and 9 industries Employment, labor productivity and plants 28 sectors and 59 countries Advantages: more observations, country fixed effect (for omitted variables), de jure and de facto regulation, income level control, etc

Results: EPLs and Job Turnover Sectors that require more flexibility are more affected by EPLs

Results: EPLs and Sector Employment Employment level (in SS) in sectors that require more flexibility is lower in countries with high EPLs.

Results: EPLs and Sector Labor Productivity Labor productivity in sectors that require more flexibility (more volatile) are not statistically different in countries with high EPLs.

Summing Up Labor Market are extremely dynamics 1/3 of job are created or destroyed during a year Firms requires to adopt their factors to this volatile environment. Reallocation is important for productivity growth. but employees require protection. UI, EPLs, EP… EPLs distort the reallocation process Reduce the speed of adjustment (moving from .67 to .57) may reduce annual growth by 0.3% Sectors that require more flexibility are more affected by EPLs. Employment in these sectors falls with EPLs (relative to other sectors) Labor productivity in these sector seems not to be affected by EPLs (relative to other sectors)

Employment Protection, Flexibility and Economic Outcome Alejandro Micco Stockholm, June 2006

Cost of increasing hours worked: Index Botero, Djankov, La Porta, Lopez de Silanes and Andrei Shleifer (QJE2003)

Job Turnover is mainly driven by idiosyncratic Shocks Source: IAD Annual Report 2004

Employment Laws Indexes Botero, Djankov, La Porta, Lopez de Silanes and Andrei Shleifer (QJE2003)

Even in narrowly defined industry there is huge heterogeneity in employment growth Exit Entry Source: IAD Annual Report 2004

But not only in employment growth, also in productivity A 100% Difference Source: IAD Annual Report 2004

and in productivity growth Source: IAD Annual Report 2004

Políticas para enfrentar la inestabilidad Los países pobres basan sus políticas en indemnizaciones y programas de empleo... ..pues son menos complejas y por tanto implican menores demandas institucionales.

Políticas para enfrentar la inestabilidad Los países pobres basan sus políticas en indemnizaciones y programas de empleo. subsidio de cesantía (15US$/mes) Indemnización Planes de empleo Chile Pre 2001:

Políticas para enfrentar la inestabilidad Los países pobres basan sus políticas en indemnizaciones y programas de empleo. ¨Seguro¨ actual subsidio de cesantía (15US$/mes) “Seguro” actual Indemnización Planes de empleo Chile Post 2001: