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Employment Protection, Firm Selection, and Growth

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Author Info
Markus Poschke () (McGill University, EUI and IZA)

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Abstract

This paper analyzes the effect of firing costs on aggregate productivity growth. For this purpose, a model of endogenous growth through selection and imitation is developed. It is consistent with recent evidence on firm dynamics and on the importance of reallocation for productivity growth. In the model, growth is driven by selection among heterogeneous incumbent firms, and is sustained as entrants imitate the best incumbents. In this framework, firing costs not only induce misallocation of labor, but also affect growth by affecting firms’ exit decisions. Importantly, charging firing costs only to continuing firms raises growth by promoting selection. Also charging them to exiting firms is akin to an exit tax, hampers selection, and reduces growth - by 0.1 percentage points in a calibrated version of the model. With job turnover very similar in the two settings, this implies that the treatment of exiting firms matters for welfare and growth. In addition, the impact on growth rates is larger in sectors where firms face larger idiosyncratic shocks, as in services. This fits evidence that recent EU-U.S. growth rate differences are largest in these sectors and implies that firing costs can play a role here. A brief empirical analysis of the impact of firing costs on the size of exiting firms supports the model’s conclusions.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 3164.

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Length: 41 pages
Date of creation: Nov 2007
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Handle: RePEc:iza:izadps:dp3164

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Related research
Keywords: endogenous growth theory; firm dynamics; labor market regulation; firing costs; entry and exit; firm selection;

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Find related papers by JEL classification:
E24 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution
J63 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Turnover; Vacancies; Layoffs
J65 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment Insurance; Severance Pay; Plant Closings
L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
L16 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Industrial Organization and Macroeconomics; Macroeconomic Industrial Structure
O40 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Bassanini, Andrea & Nunziata, Luca & Venn, Danielle, 2008. "Job Protection Legislation and Productivity Growth in OECD Countries," IZA Discussion Papers 3555, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
  2. Cristiana Benedetti Fasil, 2009. "Product and Process Innovation in a Growth Model of Firm Selection," Economics Working Papers ECO2009/30, European University Institute. [Downloadable!]
  3. Sarah Stolting, 2009. "International Trade and Growth: The Impact of Seletion and Imitation," Economics Working Papers ECO2009/21, European University Institute. [Downloadable!]
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