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Labor's Liquidity Service and Firing Costs

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  • Herman Z. Bennett
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    Abstract

    This paper proposes a new effect of firing costs on firms'' behavior that builds from firms'' demand for liquidity. When a time gap exists between production and its associated revenues, firing can become a liquidity adjustment tool that allows firms to increase their short-term liquidity. I refer to this feature as labor''s liquidity service. The presence of firing costs reduces the value of labor''s liquidity service, which affects firms'' demand for liquidity, and thus, firms'' demand for inputs. In addition to this negative effect at the creation margin, I also show that firing costs imply relatively higher destruction for financially restricted firms. I present a model that develops these ideas and show that the presence of firing costs has a stronger negative effect on production levels of firms facing liquidity constraints. Regression analysis, based on country industry panel data sets, provides empirical evidence in line with the liquidity service effect of firing costs proposed. I reject the hypothesis that the effect of firing costs does not depend on the presence of financial restrictions. I find a relatively stronger negative effect of firing costs on the output of industries with higher liquidity requirements and a relatively stronger negative effect of firing costs on the output of small firms.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/120.

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    Length: 34
    Date of creation: 01 May 2007
    Date of revision:
    Handle: RePEc:imf:imfwpa:07/120

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    Related research

    Keywords: Labor costs; Corporate sector; equation; employment; correlation; labor policy; standard errors; number of employees; statistics; employment protection; labor law; job creation; employment levels; samples; regression analysis; employment level; employment outlook; unemployment; total employment; empirical model; integral; high employment; regular employment; general equilibrium models; measurement errors; standard deviation; empirical result; labor demand; dummy variable; dynamic models; measurement error; calibrations; employment protection legislation; employment creation; equations;

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    1. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
    2. Hart, Oliver & Moore, John, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 841-79, November.
    3. Caballero, Ricardo J. & Hammour, Mohamad L., 1998. "Jobless growth: appropriability, factor substitution, and unemployment," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 48(1), pages 51-94, June.
    4. Mark Gertler & Simon Gilchrist, 1993. "Monetary policy, business cycles and the behavior of small manufacturing firms," Finance and Economics Discussion Series 93-4, Board of Governors of the Federal Reserve System (U.S.).
    5. Lazear, Edward P, 1990. "Job Security Provisions and Employment," The Quarterly Journal of Economics, MIT Press, vol. 105(3), pages 699-726, August.
    6. Michael Pries & Richard Rogerson, 2005. "Hiring Policies, Labor Market Institutions, and Labor Market Flows," Journal of Political Economy, University of Chicago Press, vol. 113(4), pages 811-839, August.
    7. Raddatz, Claudio, 2006. "Liquidity needs and vulnerability to financial underdevelopment," Journal of Financial Economics, Elsevier, vol. 80(3), pages 677-722, June.
    8. Byeongju Jeong, 2003. "The Welfare Effects of Mobility Restrictions," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(3), pages 685-696, July.
    9. Marcelo Veracierto, 2000. "Employment flows, capital mobility, and policy analysis," Working Paper Series WP-00-5, Federal Reserve Bank of Chicago.
    10. 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.
    11. Raghuram G. Rajan & Luigi Zingales, 1996. "Financial Dependence and Growth," NBER Working Papers 5758, National Bureau of Economic Research, Inc.
    12. Owen Lamont, 1996. "Cash Flow and Investment: Evidence from Internal Capital Markets," NBER Working Papers 5499, National Bureau of Economic Research, Inc.
    13. Bentolila, Samuel & Bertola, Giuseppe, 1990. "Firing Costs and Labour Demand: How Bad Is Eurosclerosis?," Review of Economic Studies, Wiley Blackwell, vol. 57(3), pages 381-402, July.
    14. Alvarez, Fernando & Veracierto, Marcelo, 2001. "Severance payments in an economy with frictions," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 477-498, June.
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