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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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    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 of Labor Economics (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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