Job protection deregulation in good and bad times

This paper explores the short-term employment effect of deregulating job protection for regular workers and how it varies with prevailing business cycle conditions. We apply the local projection method to a newly constructed dataset of major regular job protection reforms covering 26 advanced economies over the past four decades. The analysis relies on country-sector-level data, using as identifying assumption the fact that stringent dismissal regulations are more binding in sectors that are characterized by a higher ‘natural’ propensity to make regular adjustments to the workforce. We find that the response of sectoral employment to deregulation depends crucially on the state of the economy at the time of reform—deregulation increases employment if implemented during an economic expansion, but reduces employment if carried out in a recession. These findings are consistent with theory and are robust to a battery of sensitivity checks.