Human Capital, Employment Protection and Growth in Europe

Using data for 51 manufacturing and service sector for the period 1970-2005 in 14 countries, this paper show that employment protection legislation has a negative and significant effect on growth of value added and hours of work in more human capital intensive sectors. We argue that labour market regulation has a negative impact on the technology adoption mechanism through its heterogeneous impact on firms workforce adjustment requirements. In fact, technology adoption depends both on the skill level of the workforce and the capacity of firms to optimally adjust their employment levels as technology changes. As a consequence, firing costs have a relatively stronger impact in sectors in which technology adoption is more important. Our empirical results are robust to various sensitivity checks such as interactions of human capital intensity with other country level variables, of employment protection with other sector level variables and endogeneity of firing restrictions. We also show that the negative effect of EPL is stronger the smaller the distance from the technology frontier and after the 1990s.