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Alternative Labor Retrenchment Laws and Their Effect on Wages and Employment: A Theoretical Investigation with Special Reference to Developing Countries

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Author Info
Basu, Kaushik (Cornell U)
Fields, Gary S. (Cornell U)
Debgupta, Shub (PriceWaterHouseCoopers, New York, NY)

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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 antiretrenchment 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 antiretrenchment law raises wages and employment. In a subsequent section we assume that the law specifies exogenously the amount of compensation, s, that 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.

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Paper provided by Cornell University, Center for Analytic Economics in its series Working Papers with number 00-11.

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Date of creation: Sep 2000
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Handle: RePEc:ecl:corcae:00-11

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Find related papers by JEL classification:
J32 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Nonwage Labor Costs and Benefits; Private Pensions
J63 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Turnover; Vacancies; Layoffs
O15 - Economic Development, Technological Change, and Growth - - Economic Development - - - Economic Development: Human Resources; Human Development; Income Distribution; Migration
O17 - Economic Development, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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  1. Hopenhayn, Hugo & Rogerson, Richard, 1993. "Job Turnover and Policy Evaluation: A General Equilibrium Analysis," Journal of Political Economy, University of Chicago Press, vol. 101(5), pages 915-38, October. [Downloadable!] (restricted)
  2. Bentolila, Samuel & Bertola, Giuseppe, 1990. "Firing Costs and Labour Demand: How Bad Is Eurosclerosis?," Review of Economic Studies, Blackwell Publishing, vol. 57(3), pages 381-402, July. [Downloadable!] (restricted)
  3. Rama, Martin, 1999. "Public Sector Downsizing: An Introduction," World Bank Economic Review, Oxford University Press, vol. 13(1), pages 1-22, January.
  4. Bardhan, Pranab K, 1983. "Labor-Tying in a Poor Agrarian Economy: A Theoretical and Empirical Analysis," The Quarterly Journal of Economics, MIT Press, vol. 98(3), pages 501-14, August. [Downloadable!] (restricted)
  5. Fallon, Peter R. & Lucas, Robert E. B., 1993. "Job security regulations and the dynamic demand for industrial labor in India and Zimbabwe," Journal of Development Economics, Elsevier, vol. 40(2), pages 241-275, April. [Downloadable!] (restricted)
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  1. Djavad Salehi-Isfahani & Russell D. Murphy, 2006. "Labor market flexibility and investment in human capital," Working Papers e06-5, Virginia Polytechnic Institute and State University, Department of Economics. [Downloadable!]
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