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

2. 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

3. 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”

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

5. …and even more Worker Turnover

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

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

8. 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)

9. 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.

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

11. Protecting workers against labor market risks.
EPL

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

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

14. 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)

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

16. 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)

17. 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)

18. 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

19. Results: EPL and Speed of Adjustment

20. 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.

21. 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

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

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

24. 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.

25. 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)

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

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

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

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

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

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

32. and in productivity growth
Source: IAD Annual Report 2004

33. 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.

34. 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:

35. 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: