Labour Protection and Productivity in EU Economies: 1995-2005

The present study examines cross-national and sectoral differences in multifactor productivity growth in sixteen European countries from 1995 to 2005. The main aim is to ascertain the role of flexible employment contracts and collective labour relationships in explaining the ample differentials recorded in the European economy. We use the EU KLEMS database for growth accounting and a broad set of indicators of labour regulations, covering two distinct 'areas' of labour regulation: employment laws and collective relations laws. This comprehensive approach allows us to consider arrangements that regulate allocation of labour inputs (fixed-term and part-time contracts, hours worked) and the payoff and decision rights of employees. We find that, since 1995, European countries have not followed similar patterns of growth. A large number of variations between European economies are caused by marked differentials in multifactor productivity and part of this heterogeneity is caused by sectoral diversities. We show that, in labour-intensive sectors such as services, fixed-term contracts, which imply shorter-term jobs and lower employment tenures, may discourage investment in skills and have detrimental effects on multifactor productivity increases. Employment protection reforms which slacken the rules of fixed-term contracts cause potential drawbacks in terms of low productivity gains. We also find that more stringent regulation of these practices, as well as a climate of collective relations, sustain long-term relationships and mitigate these negative effects