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Labor Retrenchment Laws and their Effect on Wages and Employment: A Theoretical Investigation

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Author Info

  • Basu, Kaushik

    ()
    (World Bank)

  • Fields, Gary S.

    ()
    (Cornell University)

  • Debgupta, Shub

    ()
    (Corporate Executive Board)

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 anti-retrenchment 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 anti-retrenchment law raises wages and employment. In a subsequent section we assume that the law specifies exogenously the amount of compensation, s, 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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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 2742.

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Length: 37 pages
Date of creation: Apr 2007
Date of revision:
Handle: RePEc:iza:izadps:dp2742

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Keywords: labor laws; retrenchment; severance pay; unemployment;

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  1. 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.
  2. Meng,Xin, 2009. "Labour Market Reform in China," Cambridge Books, Cambridge University Press, number 9780521121118, October.
  3. Timothy Besley & Robin Burgess, 2002. "Can labour regulation hinder economic performance? Evidence from India," LSE Research Online Documents on Economics 3779, London School of Economics and Political Science, LSE Library.
  4. 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.
  5. Rama, Martin, 1999. "Public Sector Downsizing: An Introduction," World Bank Economic Review, World Bank Group, vol. 13(1), pages 1-22, January.
  6. Fallon, Peter R & Lucas, Robert E B, 1991. "The Impact of Changes in Job Security Regulations in India and Zimbabwe," World Bank Economic Review, World Bank Group, vol. 5(3), pages 395-413, September.
  7. 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.
  8. Basu, Kaushik, 2005. "Labor Laws and Labor Welfare in the Context of the Indian Experience," Working Papers 05-17, Cornell University, Center for Analytic Economics.
  9. Patricia M. Anderson & Bruce D. Meyer, 1994. "The Effects of Unemployment Insurance Taxes and Benefits on Layoffs Using Firm and Individual Data," NBER Working Papers 4960, National Bureau of Economic Research, Inc.
  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.
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