Offsetting the costs of employment protection?

• Pages: 197-198

Page 197

Over the past two decades, and particularly since the early 1990s, the euro area has lagged behind the United States in terms of labor productivity and income growth. Economists often attribute part of Europe's more lackluster performance to high minimum wages, generous unemployment benefits, and employment protection measures. Among advanced economies, Portugal has the most restrictive employment protection and particularly stringent dismissal restrictions. In a recent Working Paper, IMF Economist Hajime Takizawa (formerly with the European I Department and now with the Middle Eastern Department) analyzes the effect of these restrictions on Portugal's labor productivity and per capita consumption (a proxy for economic welfare).

Dismissal restrictions, such as notice and severance pay requirements, curtail labor mobility-that is, the frequency with which workers move in and out of employment and between jobs.

The more severe dismissal restrictions are, the less mobile labor tends to be. Employers' decisionmaking is also affected, since they find it more difficult and costly to lay off workers. They anticipate difficulties in dismissing employees and therefore hesitate to hire new workers.

Takizawa illustrates this using Portugal and the United States as examples. Although the average length of time that an individual is unemployed in Portugal is three times that of the United States, partly because of Portugal's strict dismissal restrictions, far fewer workers are likely to become unemployed than those in the United States-in fact, at least one-third less. As a result, the impact of dismissal restrictions on overall employment levels is ambiguous. Indeed, these two economies, which rank highest and lowest in terms of the strictness of their dismissal restrictions (see chart, this page), have tended to have some of the lowest unemployment rates among industrial countries.

Dismissal restrictions also impede the reallocation of labor to its most productive uses and reduce labor productivity and welfare. Empirical studies tend to support this argument, although they vary in their estimation of the size of productivity and welfare losses. But when labor is less mobile, jobspecific investments-such as in-house training-tend to be higher. This can raise productivity and, in theory, mitigate the losses stemming from dismissal restrictions. Takizawa examines the extent to which...