Employment Protection, International Specialization, and Innovation

This paper develops a model to analyse the implications of firing costs on incentives for R&D and international specialization. The key idea is that, to avoid paying firing costs, the country with a rigid labour market will tend to produce relatively secure goods, at late stages in their product life cycles. With international trade, an international product cycle emerges where, roughly, new goods are first produced in the low-firing cost country, and then move to the high-firing cost country. The paper shows that in the closed economy, an increase in firing costs does not necessarily imply a reduction in R&D; it crucially depends on the riskiness of R&D activity relative to productive activity. In the open economy, however, an increase in firing costs is much more likely to reduce R&D intensity.