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Effective Labor Regulation and Microeconomic Flexibility

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Author Info
Ricardo J. Caballero
Kevin N. Cowan
Eduardo M.R.A. Engel
Alejandro Micco

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Abstract

Microeconomic flexibility, by facilitating the process of creative-destruction, is at the core of economic growth in modern market economies. The main reason for why this process is not infinitely fast, is the presence of adjustment costs, some of them technological, other institutional. Chief among the latter is labor market regulation. While few economists would object to such a view, its empirical support is rather weak. In this paper we revisit this hypothesis and find strong evidence for it. We use a new sectoral panel for 60 countries and a methodology suitable for such a panel. We find that job security regulation clearly hampers the creative-destruction process, especially in countries where regulations are likely to be enforced. Moving from the 20th to the 80th percentile in job security, in countries with strong rule of law, cuts the annual speed of adjustment to shocks by a third while shaving off about one percent from annual productivity growth. The same movement has negligible effects in countries with weak rule of law.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10744.

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Date of creation: Sep 2004
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Handle: RePEc:nbr:nberwo:10744

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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
J23 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Demand
J63 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Turnover; Vacancies; Layoffs
J64 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment: Models, Duration, Incidence, and Job Search

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  2. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Blackwell Publishing, vol. 58(2), pages 277-97, April. [Downloadable!] (restricted)
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    Other versions:
  4. Ricardo J. Caballero & Eduardo M.R.A. Engel & Alejandro Micco, 2004. "Microeconomic Flexibility in Latin America," Working Papers 884, Economic Growth Center, Yale University. [Downloadable!]
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  6. Ricardo J. Caballero & Kevin N. Cowan & Eduardo M.R.A. Engel & Alejandro Micco, 2004. "Effective Labor Regulation and Microeconomic Flexibility," Cowles Foundation Discussion Papers 1480, Cowles Foundation, Yale University, revised Oct 2006. [Downloadable!]
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  27. Anderson, T. W. & Hsiao, Cheng, 1982. "Formulation and estimation of dynamic models using panel data," Journal of Econometrics, Elsevier, vol. 18(1), pages 47-82, January. [Downloadable!] (restricted)
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