Temporary employment protection and productivity growth in EU economies

• Author: Andrea RICCI,Fabrizio POMPEI,Mirella DAMIANI
• Published date: 01 December 2016
• DOI: http://doi.org/10.1111/j.1564-913X.2014.00023.x
• Date: 01 December 2016

International Labour Review, Vol. 155 (2016), No. 4

Copyright © The authors 2016

Journal compilation © International Labour Organization 2016

* Department of Economics, University of Perugia, emails: mirelladamiani@libero.it;

fabrizio.pompei@unipg.it (corresponding author). ** Italian National Institute for Vocational

Training (ISFOL), email: andr.ricci@gmail.com. The authors would like to thank participants at the

62nd Annual Meeting of the French Economic Association, held in June 2013 in Aix-en-Provence,

and the anonymous referees, for their helpful comments. They also gratefully acknowledge the

nancial support received from Fondazione Cassa di Risparmio di Perugia for research project

2010.011.0560.

Responsibility for opinions expressed in signed articles rests solely with their authors, and

publication does not constitute an endorsement by the ILO.

Temporary employment protection

and productivity growth in EU economies

Mirella DAMIANI,* Fabrizio POMPEI* and Andrea RICCI**

Abstract. This article examines national and industry-level differences in total

factor productivity (TFP), or efciency, for 14 European countries and ten indus-

tries for the period 1995 –200 7. The main aim is to ascertain the extent to which

employment protection legislation (EPL) for workers with temporary contracts

affects TFP, based on difference-in-difference estimations. The results show that

the deregulation of temporary employment negatively affects TFP growth in Euro-

pean economies and that, at industry level, this liberalization affects industries

with a higher propensity to use temporary workers. Furthermore, the authors nd

that the deregulation of temporary employment discourages training and the ac-

quisition of rm-specic skills.

T

his article analyses disparities in productivity across European Union (EU)

economies over the period 1995 –200 7, which was characterized by a

marked slowdown of average European efciency growth and by signicant

cross-country differences. Other studies have shown that in the period from

the mid–1990s up to 20 05, EU countries lost ground compared to the United

States, not because of adverse changes in labour composition or insufcient

rates of capital accumulation, but owing to a lack of innovation capability

(Inklaar, Timmer and van Ark, 2008; van Ark, O’Mahony and Timmer, 2008).

These earlier studies also found that a prominent role in explaining differ-

ences in cross-country labour productivity was played by growth in total fac-

tor productivity (TFP) – the measure of production efciency that reects

technological changes that are not embodied in the quality of inputs and are

attributable to organizational and institutional determinants. In addition, dif-

ferentials across European economies in the rates of efciency gains in the use

International Labour Review588

of inputs were found to involve mainly market services, which were marked

by a widening productivity gap with respect to other industries (Inklaar, Tim-

mer and van Ark, 2008).

The main aim of this article is to examine more closely the role of labour

market reforms in the area of temporary employment. More specically, the art-

icle highlights the key role of employment protection legislation for workers

with temporary contracts (EPLT) in explaining TFP growth disparities between

EU economies, and industries. The effect of EPLT is evaluated not only in ab-

solute terms, but also relative to employment protection legislation for workers

with regular – i.e. open-ended – contracts (EPLR). The inclusion of stringency

of EPLR does not alter our results, which unambiguously show that deregula-

tion of temporary employment negatively affects labour market performance.

From the mid-1990s onwards, Europe saw the liberalization of its labour

markets. Among the main policy reversals, new regulatory frameworks for

temporary employment were introduced. These reforms were implemented in

various countries, albeit at different speeds, and were more frequently adopted

than reforms affecting open-ended employment. As a result, there has been

a steady rise in temporary employment in a number of European economies,

with aggregate evidence showing that approximately 14 per cent of EU em-

ployees have temporary contracts (OECD, 2011).

The underlying reasons for the promotion of labour market exibility

can be found in the theoretical literature on the potential costs and benets of

EPLT. Temporary employment may have two probable but opposing effects on

productivity. On the one hand, temporary contracts favour labour reallocation

processes triggered by technology or demand shocks that call for faster adapta-

tion and changes in the skill content of jobs. They may also have an incentive

effect, assuming that temporary workers aim to obtain open-ended positions.

Hence, these arrangements may serve as screening devices for the selection

of new employees (Engellandt and Riphahn, 2005). In addition, in the case

of stringent EPLR, temporary workers act as “buffer stock”, since rms can

adjust their workforces by varying the number of temporary contracts, thus

quickly responding to changes in demand and technology.

On the other hand, as theoretically argued by Blanchard and Landier

(2002), the deregulation of temporary employment may merely increase turn-

over in the labour market, since open-ended contracts remain costly to dissolve

owing to stringent dismissal regulations, including high ring costs. Indeed,

rms can be reluctant to retain workers after their temporary contracts expire

and hire them for open-ended jobs, even if the “match” is productive. The same

authors also offer evidence from France for the period 1983–200 0, which un-

ambiguously conrms that partial reforms in employment protection may be

perverse: when rms are allowed to hire workers on temporary contracts, the

outcomes are “more low productivity entry-level jobs, fewer regular jobs and

so, lower overall productivity and output” (ibid., p. F215).

In the same vein, Boeri and Garibaldi (2007) focus on the transitional

“honeymoon effect” of labour market reforms, which aim to increase exi-

Temporary employment protection and TFP growth 589

bility “at the margin”. Using a dynamic model of labour demand in Italy, they

argue that two-tiered reforms produce an increase in short-term employment

but also a slowdown in productivity caused by a decrease in the marginal re-

turns of labour services (ibid.).

Additional considerations relate to human capital accumulation and pro-

ductivity. Indeed, as shown by Belot, Boone and van Ours (2007), employment

protection encourages employees to invest in match-specic human capital,

thereby increasing the probability of the survival of the match; this benecial

effect is stronger in industries where rms have greater competency special-

ization. This outcome is also more relevant in all contexts where risk-averse

employees are liquidity-constrained and cannot obtain insurance against dis-

missal. However, as argued by the authors, there is a trade-off between these

positive effects and the negative consequences of EPL, which also increases

the cost of separation; in other words, stronger EPL improves workers’ wel-

fare and productivity, but only up to a certain point (ibid.).

More general results that are not conditioned by the presence of risk-

averse employees and nancial imperfections are obtained by Ricci and Wald-

man (2010). In their matching model, which is similar to that of Mortensen

and Pissarides (1994), workers have no inuence over the amount of training

available to them, which is chosen unilaterally by their employers; also, a well-

designed policy that combines taxes for ring newly hired personnel, and hir-

ing subsidies, always increases the level of training and job tenure, with clear

positive effects on welfare.

There is limited comparative empirical evidence thus far on the relation-

ship between EPL and productivity, and even scarcer evidence with regard to

EPLT. The few empirical analyses that have estimated the extent to which EPL

affects productivity – such as Nickell and Layard (1999) and Dew-Becker and

Gordon (2012) – were based on aggregate regression analysis. However, the

validity of these types of investigations may be limited by confounding factors

that inuence the cross-country effects of EPL. This problem is addressed by

Micco and Pagés (2006) and Bassanini, Nunziata and Venn (20 09), who use

a difference-in-difference method to estimate the impact of national institu-

tional variables, controlling for industry effects.

This article adopts the same difference-in-difference method, but pays

special attention to EPLT, rather than focusing on aggregate measures of em-

ployment protection or on EPLR. However, all our estimates, as mentioned

above, also take into account the role of dismissal regulations – captured by

the EPLR indicator – to evaluate whether the same results regarding the de-

regulation of temporary employment are found when ring restrictions are

taken into account. In addition, to better control for these dismissal regulations,

we provide separate estimates of the role of regulations concerning both indi-

vidual and collective dismissals. This estimation strategy allows us to ascertain

the role of EPLT in explaining the considerable differences in TFP recorded

in EU economies, also relative to other employment protection provisions. We

nd that the deregulation of temporary employment negatively affects TFP