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Firing Cost and Firm Size: A Study of Sri Lanka's Severance Pay System

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  • Abidoye, Babatunde
  • Orazem, Peter
  • Vodopivec, Milan

Abstract

Sri Lanka's Termination of Employment of Workmen Act (TEWA) requires that firms with 15 or more employees justify layoffs and provide generous severance pay to displaced workers, with smaller firms being exempted. Athough formally subject to TEWA, firms in Export Processing Zones (EPZs) may have been partially exempt from TEWA due to lax enforcement in that sector. A theoretical model shows that firms subject to TEWA will tend to mass at or below the threshold of 14 workers until they get an atypically large productivity shock that would propel them beyond the threshold. EPZ firms will be largely unaffected by the law. In addition, EPZ firms receive preferential tax treatment and exemptions from customs duty. Consequently, firms that anticipate rapid growth will have an incentive to locate in the EPZ sector. We test these predictions using 1995-2003 panel data on the universe of all private, formal sector firms in Sri Lanka. We find that at all sizes, EPZ firms are more likely to add employees than nonEPZ firms. Above the threshold, nonEPZ firms are more likely to shed workers while EPZ firms are more likely to add workers. Once passing the threshold, nonEPZ firms grow faster than nonEPZ firms below the threshold, consistent with a theoretical prediction that only atypically productive nonEPZ firms would cross the threshold. Finally, evidence is consistent with the the hypothesis that TEWA restrictions retard the growth of nonEPZ firms below the threshold, but only some of the evidence passes tests of statistical significance. The combined impacts of retarded growth below the threshold, the need for a large productivity shock to cross the threshold, and slower employment growth above the threshold suggest that the TEWA failed to lower unemployment. Instead, it slowed employment growth of nonEPZ firms and induced other firms to seek the EPZ sector in order to evade the law.

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Bibliographic Info

Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number 12922.

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Date of creation: 20 Apr 2008
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Handle: RePEc:isu:genres:12922

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Postal: Iowa State University, Dept. of Economics, 260 Heady Hall, Ames, IA 50011-1070
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Web page: http://www.econ.iastate.edu
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Keywords: severance; firing costs; layoff restrictions; Sri Lanka; employment growth; export promotion; threshold;

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References

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  1. Richard B. Freeman, 2007. "Labor Market Institutions Around the World," NBER Working Papers 13242, National Bureau of Economic Research, Inc.
  2. Andrew Glyn, 2003. "Labor Market Institutions and Unemployment: A Critical Assessment of the Cross-Country Evidence," Economics Series Working Papers 168, University of Oxford, Department of Economics.
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  8. World Bank, 2007. "Sri Lanka : Strengthening Social Protection," World Bank Other Operational Studies 19638, The World Bank.
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Cited by:
  1. Garicano, Luis & Lelarge, Claire & Van Reenen, John, 2013. "Firm Size Distortions and the Productivity Distribution: Evidence from France," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9495, C.E.P.R. Discussion Papers.
  2. Holzmann, Robert, 2010. "Bringing financial literacy and education to low and middle income countries : the need to review, adjust, and extend current wisdom," Social Protection Discussion Papers 56501, The World Bank.
  3. Chae, ChangKyun & Chung, Jaeho, 2009. "Pre-employment vocational education and training in Korea," Social Protection Discussion Papers 52186, The World Bank.
  4. Milan Vodopivec, 2013. "Introducing unemployment insurance to developing countries," IZA Journal of Labor Policy, Springer, Springer, vol. 2(1), pages 1-23, December.
  5. Lord, Janet & Posarac, Aleksandra & Nicoli, Marco & Peffley, Karen & Mcclain-Nhlapo, Charlotte & Keogh, Mary, 2010. "Disability and international cooperation and development : a review of policies and practices," Social Protection Discussion Papers 56092, The World Bank.
  6. McKenzie, David, 2009. "Impact assessments in finance and private sector development : what have we learned and what should we learn ?," Policy Research Working Paper Series 4944, The World Bank.
  7. James, Estelle, 2009. "Rethinking survivor benefits," Social Protection Discussion Papers 52919, The World Bank.
  8. Ra, Young-Sun & Shim, Kyung Woo, 2009. "The Korean case study : past experience and new trends in training policies," Social Protection Discussion Papers 53696, The World Bank.
  9. Danielle Venn, 2009. "Legislation, Collective Bargaining and Enforcement: Updating the OECD Employment Protection Indicators," OECD Social, Employment and Migration Working Papers 89, OECD Publishing.
  10. Parsons, Donald O., 2011. "Mandated Severance Pay and Firing Cost Distortions: A Critical Review of the Evidence," IZA Discussion Papers 5776, Institute for the Study of Labor (IZA).
  11. Rita K. Almeida & Z. Bilgen Susanlı, 2012. "Firing Regulations and Firm Size in the Developing World: Evidence from Differential Enforcement," Review of Development Economics, Wiley Blackwell, Wiley Blackwell, vol. 16(4), pages 540-558, November.
  12. Woo, Kye Lee, 2009. "Productivity increases in SMEs : with special emphasis on in-service training of workers in Korea," Social Protection Discussion Papers 51251, The World Bank.
  13. Parsons, Donald O., 2013. "Understanding Severance Pay," IZA Discussion Papers 7641, Institute for the Study of Labor (IZA).
  14. Piggott, John & Sane, Renuka, 2009. "Indexing pensions," Social Protection Discussion Papers 52445, The World Bank.

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