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Labor Market Reforms, Job Instability, and the Flexibility of the Employment Relationship

  • Niko Matouschek
  • P Ramezzana
  • Frédéric Robert-Nicoud

We endogenize separation in a search model of the labor market and allow for bargaining over the continuation of employment relationships following productivity shocks to take place under asymmetric information. In such a setting separation may occur even if continuation of the employment relationship is privately efficient for workers and firms. We show that reductions in the cost of separation, owing for example to a reduction in firing taxes, lead to an increase in job instability and, when separation costs are initially high, may be welfare decreasing for workers and firms. We furthermore show that, in response to an exogenous reduction in firing taxes, workers and firms may switch from rigid to flexible employment contracts, which further amplifies the increase in job instability caused by policy reform.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp0865.

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Date of creation: Apr 2008
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Handle: RePEc:cep:cepdps:dp0865
Contact details of provider: Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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  1. Cesar Alonso-Borrego & Jesus Fernandez-Villaverde & Jose Galdon-Sanchez, 2004. "Evaluating Labor Market Reforms: A General Equilibrium Approach," Working Papers 866, Princeton University, Department of Economics, Industrial Relations Section..
  2. Alvarez, Fernando & Veracierto, Marcelo, 2001. "Severance payments in an economy with frictions," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 477-498, June.
  3. Alonso-Borrego, César & Fernández-Villaverde, Jesús & Galdon-Sanchez, Jose Enrique, 2004. "Evaluating Labor Market Reforms: A General Equilibrium Approach," IZA Discussion Papers 1129, Institute for the Study of Labor (IZA).
  4. Moen, Espen R & Rosén, Åsa, 2006. "Incentives in Competitive Search Equilibrium and Wage Rigidity," CEPR Discussion Papers 5554, C.E.P.R. Discussion Papers.
  5. L. Rachel Ngai & Christopher Pissarides, 2008. "Employment outcomes in the welfare state," LSE Research Online Documents on Economics 3525, London School of Economics and Political Science, LSE Library.
  6. Moen, Espen R, 1997. "Competitive Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 385-411, April.
  7. Schmitz, Patrick W., 2004. "Job protection laws and agency problems under asymmetric information," European Economic Review, Elsevier, vol. 48(5), pages 1027-1046, October.
  8. Niko Matouschek, 2004. "Ex Post Inefficiencies in a Property Rights Theory of the Firm," Journal of Law, Economics and Organization, Oxford University Press, vol. 20(1), pages 125-147, April.
  9. Faig, Miquel & Jerez, Belen, 2005. "A theory of commerce," Journal of Economic Theory, Elsevier, vol. 122(1), pages 60-99, May.
  10. Christopher A. Pissarides, 2000. "Equilibrium Unemployment Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262161877, June.
  11. Burguet, Roberto & Caminal, Ramon & Matutes, Carmen, 2002. "Golden cages for showy birds: Optimal switching costs in labor contracts," European Economic Review, Elsevier, vol. 46(7), pages 1153-1185, July.
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