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Labor Retrenchment Laws and their Effect on Wages and Employment: A Theoretical Investigation

Author

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  • Basu, Kaushik

    () (World Bank)

  • Fields, Gary S.

    () (Cornell University)

  • Debgupta, Shub

    () (Corporate Executive Board)

Abstract

Many countries have legislation which make it costly for firms to dismiss or retrench workers. In the case of India, the Industrial Disputes Act, 1947, requires firms that employ 50 or more workers to pay a compensation to any worker who is to be retrenched. This paper builds a theoretical model to analyze the effects of such anti-retrenchment laws. Our model reveals that an anti-retrenchment law can cause wages and employment to rise or fall, depending on the parametric conditions prevailing in the market. We then use this simple model to isolate conditions under which an anti-retrenchment law raises wages and employment. In a subsequent section we assume that the law specifies exogenously the amount of compensation, s, a firm has to pay each worker who is being dismissed. It is then shown that as s rises, starting from zero, equilibrium wages fall. However beyond a certain point, further rises in s cause wages to rise. In other words, the relation between the exogenously specified cost to the firm of dismissing a worker and the equilibrium wage is V-shaped.

Suggested Citation

  • Basu, Kaushik & Fields, Gary S. & Debgupta, Shub, 2007. "Labor Retrenchment Laws and their Effect on Wages and Employment: A Theoretical Investigation," IZA Discussion Papers 2742, Institute for the Study of Labor (IZA).
  • Handle: RePEc:iza:izadps:dp2742
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    References listed on IDEAS

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    1. Pranab K. Bardhan, 1983. "Labor-tying in a Poor Agrarian Economy: A Theoretical and Empirical Analysis," The Quarterly Journal of Economics, Oxford University Press, vol. 98(3), pages 501-514.
    2. Basu, Kaushik, 2005. "Labor Laws and Labor Welfare in the Context of the Indian Experience," Working Papers 05-17, Cornell University, Center for Analytic Economics.
    3. Mrinal Datta Chaudhuri, 1994. "Labour Markets As Social Institutions In India," Working papers 16, Centre for Development Economics, Delhi School of Economics.
    4. Meng,Xin, 2009. "Labour Market Reform in China," Cambridge Books, Cambridge University Press, number 9780521121118.
    5. Rama, Martin, 1999. "Public Sector Downsizing: An Introduction," World Bank Economic Review, World Bank Group, vol. 13(1), pages 1-22, January.
    6. Samuel Bentolila & Giuseppe Bertola, 1990. "Firing Costs and Labour Demand: How Bad is Eurosclerosis?," Review of Economic Studies, Oxford University Press, vol. 57(3), pages 381-402.
    7. Timothy Besley & Robin Burgess, 2004. "Can Labor Regulation Hinder Economic Performance? Evidence from India," The Quarterly Journal of Economics, Oxford University Press, vol. 119(1), pages 91-134.
    8. Fallon, Peter R & Lucas, Robert E B, 1991. "The Impact of Changes in Job Security Regulations in India and Zimbabwe," World Bank Economic Review, World Bank Group, vol. 5(3), pages 395-413, September.
    9. Fallon, Peter R. & Lucas, Robert E. B., 1993. "Job security regulations and the dynamic demand for industrial labor in India and Zimbabwe," Journal of Development Economics, Elsevier, vol. 40(2), pages 241-275, April.
    10. Hopenhayn, Hugo & Rogerson, Richard, 1993. "Job Turnover and Policy Evaluation: A General Equilibrium Analysis," Journal of Political Economy, University of Chicago Press, vol. 101(5), pages 915-938, October.
    11. Patricia M. Anderson & Bruce D. Meyer, 1994. "The Effects of Unemployment Insurance Taxes and Benefits on Layoffs Using Firm and Individual Data," NBER Working Papers 4960, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Indranil Bose & R. K. Mudgal, 2016. "Impact of Globalization on Job-Abolition and Job-Creation in Recent Times: A Brief Research Overview," Journal of Applied Management and Investments, Department of Business Administration and Corporate Security, International Humanitarian University, vol. 5(4), pages 223-228, November.

    More about this item

    Keywords

    labor laws; retrenchment; severance pay; unemployment;

    JEL classification:

    • O15 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Economic Development: Human Resources; Human Development; Income Distribution; Migration
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements
    • J32 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Nonwage Labor Costs and Benefits; Retirement Plans; Private Pensions
    • J63 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Turnover; Vacancies; Layoffs

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