It is frequently argued that pure government-mandated severance transfers by the employer to the worker have neither employment nor welfare effect because they can be offset by private transfers from the worker to the employer. In this paper, using a dynamic search and matching model à la Mortensen and Pissarides (1994), we show that it may be not any more the case if labor contracts are incomplete and canbe renegotiated by mutual agreement only. Indeed, we show that increases in high severance payments are likely to decrease unemployment but systematically decrease welfare and raise inequality. Moreover, it can be understood that insiders try to get high severance payments through political channel, although they do not fight for such a type of advantage at the firm level.
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Find related papers by JEL classification: H29 - Public Economics - - Taxation, Subsidies, and Revenue - - - Other J23 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Demand J38 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Public Policy J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts J64 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment: Models, Duration, Incidence, and Job Search
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