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Labor-market Frictions, Incomplete Insurance and Severance Payments

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  • Etienne Lalé

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Abstract

We analyze the effects of mandated severance payments in an economy with search and matching in the labor market, risk-averse individuals and imperfect insurance against shocks. Our model emphasizes a tension between efficient worker-firm bargains and consumption smoothing: a well-designed contract dictates a downward shift in entry wages to offset expected severance payments, and thus goes against having a smooth consumption path. As a result, we find that severance payments produce mostly negative welfare effects. There are large allocation and welfare effects in the absence of savings which limits the response of wages to severance payments. With savings, the impact on equilibrium allocations is considerably dampened, but the welfare losses remain substantial.

Suggested Citation

  • Etienne Lalé, 2014. "Labor-market Frictions, Incomplete Insurance and Severance Payments," Bristol Economics Discussion Papers 14/648, Department of Economics, University of Bristol, UK, revised 16 Aug 2016.
  • Handle: RePEc:bri:uobdis:14/648
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    File URL: http://www.efm.bris.ac.uk/economics/working_papers/pdffiles/dp16648.pdf
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    References listed on IDEAS

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    1. Mortensen, Dale & Pissarides, Christopher, 2011. "Job Creation and Job Destruction in the Theory of Unemployment," Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 1, pages 1-19.
    2. Giuseppe Bertola, 2004. "A Pure Theory of Job Security and Labour Income Risk," Review of Economic Studies, Oxford University Press, vol. 71(1), pages 43-61.
    3. Fella Giulio & Tyson Christopher J., 2013. "Privately optimal severance pay," The B.E. Journal of Macroeconomics, De Gruyter, vol. 13(1), pages 1-39, October.
    4. Burda, Michael C, 1992. " A Note on Firing Costs and Severance Benefits in Equilibrium Unemployment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 94(3), pages 479-489.
    5. Alain Delacroix & Etienne Wasmer, 2009. "Layoff Costs and Efficiency with Asymmetric Information," Sciences Po publications info:hdl:2441/5l6uh8ogmqi, Sciences Po.
    6. Fabien Postel‐Vinay & Hélène Turon, 2014. "The Impact of Firing Restrictions on Labour Market Equilibrium in the Presence of On‐the‐job Search," Economic Journal, Royal Economic Society, vol. 124(575), pages 31-61, March.
    7. Adriana D. Kugler & Gilles Saint-Paul, 2004. "How Do Firing Costs Affect Worker Flows in a World with Adverse Selection?," Journal of Labor Economics, University of Chicago Press, vol. 22(3), pages 553-584, July.
    8. Gilles Saint-Paul, 1995. "The High Unemployment Trap," The Quarterly Journal of Economics, Oxford University Press, vol. 110(2), pages 527-550.
    9. Fella, Giulio, 2007. "When do firing taxes matter?," Economics Letters, Elsevier, vol. 97(1), pages 24-31, October.
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    Cited by:

    1. Dolado, Juan J. & Lalé, Etienne & Siassi, Nawid, 2016. "From Dual to Unified Employment Protection: Transition and Steady State," IZA Discussion Papers 9953, Institute for the Study of Labor (IZA).

    More about this item

    Keywords

    Severance Payments; Labor-market Frictions; Precautionary Savings; Welfare;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • I38 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - Government Programs; Provision and Effects of Welfare Programs
    • J63 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Turnover; Vacancies; Layoffs
    • J65 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment Insurance; Severance Pay; Plant Closings

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