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Firing cost and firm size : a study of Sri Lanka's severance pay system

  • Abidoye, Babatunde
  • Orazem, Peter F.
  • Vodopivec, Milan

Consistent with its focus on social policies, Sri Lanka has devoted significant attention to worker protection. One of the main pillars of its worker protection policy is the Termination of Employment of Workman Act (TEWA) introduced in 1971. The act aims to limit unemployment by raising the cost of layoffs. The act requires that each layoff of a covered worker, whether individual or as a part of a mass layoff, must be approved by the government. Until recently, the government also decided on a case-by-case basis the level of severance pay the firm had to pay to the laid off workers. Since its introduction, critics have argued that the TEWA's non-transparent, discretionary, and costly regulations discourage employment growth, hinder reallocation of labor from inefficient firms to more profitable sectors, slow the introduction of new technologies, and increase unemployment. Defenders including trade unions and the government argue that on the contrary, severance pay promotes longer-lasting employment relationships that improve incentives for training and enhance cooperation and trust between employers and workers. The paper is organized as follows: section two provides an institutional background, highlighting the intensions of the TEWA at its introduction, and it's the provisions and procedures. Section three presents the theoretical framework and formulates hypotheses to be empirically tested. Section four describes the data and the identification strategy devised to identify the employment effects of TEWA. Section five presents the empirical results based on the estimation of the multinomial model of employment growth of firms. Section six concludes witha summary and policy recommendations.

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Paper provided by The World Bank in its series Social Protection Discussion Papers with number 50671.

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Date of creation: 01 Sep 2009
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Handle: RePEc:wbk:hdnspu:50671
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  1. Andrew Glyn, 2003. "Labor Market Institutions and Unemployment: A Critical Assessment of the Cross-Country Evidence," Economics Series Working Papers 168, University of Oxford, Department of Economics.
  2. Richard B. Freeman, 2008. "Labor market institutions around the world," LSE Research Online Documents on Economics 19647, London School of Economics and Political Science, LSE Library.
  3. Addison, John T. & Teixeira, Paulino, 2001. "The Economics of Employment Protection," IZA Discussion Papers 381, Institute for the Study of Labor (IZA).
  4. James J. Heckman & Carmen Pages, 2000. "The Cost of Job Security Regulation: Evidence from Latin American Labor Markets," NBER Working Papers 7773, National Bureau of Economic Research, Inc.
  5. Richard Layard & Stephen Nickell, 1998. "Labour Market Institutions and Economic Performance," CEP Discussion Papers dp0407, Centre for Economic Performance, LSE.
  6. Ahsan, Ahmad & Pages, Carmen, 2007. "Are all labor regulations equal ? Assessing the effects of job security, labor dispute, and contract labor laws in India," Policy Research Working Paper Series 4259, The World Bank.
  7. Liedholm, Carl & Mead, Donald C., 1987. "Small Scale Industries in Developing Countries: Empirical Evidence and Policy Implications," Food Security International Development Papers 54062, Michigan State University, Department of Agricultural, Food, and Resource Economics.
  8. World Bank, 2007. "Sri Lanka : Strengthening Social Protection," World Bank Other Operational Studies 19638, The World Bank.
  9. Carmen Pagés-Serra, 2000. "The Cost of Job Security Regulation: Evidence from Latin American Labor Markets," ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION, ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION.
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