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Labor market rigidities and unemployment: the case of severance costs

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  • Michael K. Gavin
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    Abstract

    It is frequently alleged that the persistent, high rates of unemployment in many European countries are due, at least in part, to various labor market rigidities. One of these rigidities is the high cost of firing workers, compared with the cost in the United States, or in Europe in the early 1960s. ; This paper assesses the empirical importance of severance costs on labor demand. A partial equilibrium model of the firm's employment decision in the presence of significant severance costs is formulated and solved. The theoretical section of the paper identifies the following determinants of the impact of severance costs on labor demand: (1) the size of the required severance payments, (2) the variability and persistence of shocks to labor demand, (3) the expected rate of growth of labor demand, (4) the rate at which workers voluntarily leave the firm to retire or take other jobs, (5) the wage elasticity of labor demand, and (6) the firm's discount rate. ; The analytical framework is then used to evaluate the impact of severance costs on the expected cost of hiring a worker, and hence on labor demand. These costs are evaluated for a plausible base case, and the sensitivity of the conclusions to alternative assumptions is investigated.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 284.

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    Date of creation: 1986
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    Handle: RePEc:fip:fedgif:284

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    Keywords: Unemployment ; Labor market;

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    Cited by:
    1. Bar-Ilan, Avner & Levy, Anat, 1993. "Job search by employed workers : the effects of restrictions," Policy Research Working Paper Series 1170, The World Bank.
    2. Booth, Alison L. & Zoega, Gylfi, 2003. "On the welfare implications of firing costs," European Journal of Political Economy, Elsevier, vol. 19(4), pages 759-775, November.
    3. Adriana Kugler, 1999. "The Impact of Firing Costs on Turnover and Unemployment: Evidence from the Colombian Labour Market Reform," International Tax and Public Finance, Springer, vol. 6(3), pages 389-410, August.
    4. Soltwedel, RĂ¼diger & Bothe, Adrian & Hoffmeyer, Martin & Laaser, Claus-Friedrich & Lammers, Konrad & Merz, Monika & Reuter, Dieter, 1990. "Regulierungen auf dem Arbeitsmarkt der Bundesrepublik," Open Access Publications from Kiel Institute for the World Economy 418, Kiel Institute for the World Economy (IfW).
    5. Risager, Ole & Sorensen, Jan Rose, 1997. "On the effects of firing costs when investment is endogenous: An extension of a model by Bertola," European Economic Review, Elsevier, vol. 41(7), pages 1343-1353, July.
    6. Agenor, Pierre-Richard, 2003. "The mini-integrated macroeconomic model for poverty analysis : a framework for analyzing the unemployment and poverty effects of fiscal and labor market reforms," Policy Research Working Paper Series 3067, The World Bank.
    7. Adriana Kugler, 2000. "The Incidence of Job Security Regulations on Labor Market Flexibility and Compliance in Colombia: Evidence from the 1990 Reform," Research Department Publications 3094, Inter-American Development Bank, Research Department.

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