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How Do Firing Costs Affect Innovation and Growth when Workers' Ability is Unknown? Employment Protection as a Burden on a Firm's Screening Process

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  • Binyamin Berdugo
  • Sharon Hadad

Abstract

This paper analyzes the implication of employment protection legislation on a firm's screening process. We present a model in which human-capital-intensive firms (high-tech firms) with imperfect information about their workers' type attempt during a trial period to identify those incompetent workers they will subsequently dismiss. However, employment protection measures place a burden on this screening process thereby motivating innovators to embark on medium-tech projects which are more flexible in their human capital requirements. As such, employment protection legislation distorts the pattern of specialization in favor of medium-tech firms over high-tech firms and consequently slows down the process of economic growth. The results of the paper are consistent with documented data on Europe versus US productivity growth and specialization patterns.

Suggested Citation

  • Binyamin Berdugo & Sharon Hadad, 2012. "How Do Firing Costs Affect Innovation and Growth when Workers' Ability is Unknown? Employment Protection as a Burden on a Firm's Screening Process," European Journal of Comparative Economics, Cattaneo University (LIUC), vol. 9(1), pages 3-30, April.
  • Handle: RePEc:liu:liucej:v:9:y:2012:i:1:p:3-30
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    Keywords

    Severance Payments; Firing Costs; Screening Costs; Specialization; Growth;

    JEL classification:

    • J2 - Labor and Demographic Economics - - Demand and Supply of Labor
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General
    • F16 - International Economics - - Trade - - - Trade and Labor Market Interactions
    • K31 - Law and Economics - - Other Substantive Areas of Law - - - Labor Law

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