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Employment protection legislation (EPL) includes all types of employment protection measures, whether grounded primarily in legislation, court rulings, collectively bargained conditions of employment, or customary practice. The term is common among circles of
economist An economist is a professional and practitioner in the social sciences, social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy. Within this ...
s. Employment protection refers both to regulations concerning hiring (e.g. rules favouring disadvantaged groups, conditions for using temporary or fixed-term contracts, training requirements) and firing (e.g. redundancy procedures, mandated prenotification periods and severance payments, special requirements for collective dismissals and short-time work schemes). There exist various institutional arrangements that can provide employment protection: the private market, labour legislation, collective bargaining arrangements and not the least, court interpretations of legislative and contractual provisions. Some forms of de facto regulations are likely to be adopted even in the absence of legislation, simply because both workers and firms derive advantages from long-term employment relations.


Definition

According to Barone (2001) with the acronym EPL economists refer to the entire set of regulations that place some limits to the faculties of firms to hire and fire workers, even if they are not grounded primarily in the law, but originate from the
collective bargaining Collective bargaining is a process of negotiation between employers and a group of employees aimed at agreements to regulate working salaries, working conditions, benefits, and other aspects of workers' compensation and labour rights, rights for ...
of the social partners, or are a consequence of court rulings.Barone, Andrea (2001): ''Employment protection legislation: a critical review of the literature''. Taken from www.cesifin.i

.
In particular, provisions favouring the employment of disadvantaged groups in society, determining the conditions for the use of temporary contract, temporary or fixed-term contracts, or imposing training requirements on the firm, affect hiring policies, while redundancy procedures, mandated pre-notification periods and severance payments, special requirements for collective dismissals and short-time work schemes influence firing decisions. The nature of these restrictions on the firms’ freedom to adjust the labour input is quite similar in all OECD countries, but the actual procedural details and the overall degree of stringency implied by them varies considerably. These provisions are enforced through the worker’s right to appeal against his lay-off. Some aspects of these regulations, like the length of advance notices or the dimension of severance payments can be measured with precision. Other important features of EPL, like for example the willingness of labour courts to entertain appeals by fired workers, or how judges interpret the concept of “just cause” for termination, are much more difficult to quantify.


Employment Protection Legislation Index by the OECD

One of the more frequently used measures of the strictness of the EPL in each country and through different years is the so-called Employment Protection Legislation Index elaborated by the
OECD The Organisation for Economic Co-operation and Development (OECD; , OCDE) is an international organization, intergovernmental organization with 38 member countries, founded in 1961 to stimulate economic progress and international trade, wor ...
. This index is calculated along 18 basic items, which can be classified in three main areas: # Employment protection of regular workers against individual dismissal; # Specific requirements for collective dismissals; and # Regulation of temporary forms of employment. The 18 first-digit inputs are then expressed in either of the following forms: # Units of time (e.g. delays before notice can start, or months of notice and severance pay); # As a number (e.g. maximum number of successive fixed-term contracts allowed); or # As a score on an ordinal scale specific to each item (0 to 2, 3, 4 or simply yes/no). Then, these different scoring is converted into cardinal scores that are normalized to range from 0 to 6, with higher scores representing stricter regulation. Therefore, each of the different items is normalized according to weighted averages, thus constructing three sets of summary indicators that correspond to successively more aggregated measures of EPL strictness. The last step of the procedure involves computing, for each country, an overall summary indicator based on the three subcomponents: #Strictness of regulation for regular contracts, #Temporary contracts, and #Collective dismissals. The summary measure for collective dismissals is attributed just 40% of the weight assigned to regular and temporary contracts. The rationale for this is that the collective dismissals indicator only reflects additional employment protection triggered by the collective nature of the dismissal. In most countries, these additional requirements are quite modest. Moreover, summary measures for collective dismissals are only available since the late 1990s. An alternative overall index, so-called Version 1, has been thus calculated as an unweighted average of the summary measures for regular and temporary contracts only. While more restrictive than the previous one (so-called Version 2), this alternative measure of the overall EPL strictness allows comparisons over a longer period of time (since the late 1980s compared with the late 1990s).


Effects of employment protection legislation


On the duality of the labour market

Some economists have claimed that empirical evidence gives support to their theories, according to which EPL leads to a segmentation in the
labour market Labour or labor may refer to: * Childbirth, the delivery of a baby * Labour (human activity), or work ** Manual labour, physical work ** Wage labour, a socioeconomic relationship between a worker and an employer ** Organized labour and the labou ...
between the so-called ''insiders'', the workers with a protected job, and the ''outsiders'', who are people that are either unemployed or employed with fixed-term, part-time or temporary contract, temporary contracts, or even in the black economy, and face big difficulties to find a job covered by EPL because of the firms’ reduced propensity to hire. This latter group is mainly constituted by youths, women, racial minorities and unskilled workers.


On unemployment

Whether EPL has any effect on unemployment is an issue of contention between economists. On the one hand, assuming that the cyclical wage pattern is not affected by mandated firing costs, EPL reduces the propensity to hire by employers, since they fear that such decisions will be difficult to reverse in the future, in case of a recession. On the other hand, EPL also leads firms during downswings to keep more workers employed, than they would have otherwise done. Therefore, EPL reduces both job creation and job destruction, so that the net effects on average
employment Employment is a relationship between two party (law), parties Regulation, regulating the provision of paid Labour (human activity), labour services. Usually based on a employment contract, contract, one party, the employer, which might be a cor ...
and
unemployment Unemployment, according to the OECD (Organisation for Economic Co-operation and Development), is the proportion of people above a specified age (usually 15) not being in paid employment or self-employment but currently available for work du ...
are not identifiable a priori. What is instead agreed among economists, is that more stringent EPL lowers the fluctuations in the quantity of labour
demand In economics, demand is the quantity of a goods, good that consumers are willing and able to purchase at various prices during a given time. In economics "demand" for a commodity is not the same thing as "desire" for it. It refers to both the desi ...
ed over the
business cycle Business cycles are intervals of general expansion followed by recession in economic performance. The changes in economic activity that characterize business cycles have important implications for the welfare of the general population, governmen ...
, leading to smoother dynamic patterns of those aggregates. Economists considering that EPL has no effect on unemployment include Blanchard and Portugal (2000). In their article they compare two opposite countries as regards their EPL stance:
Portugal Portugal, officially the Portuguese Republic, is a country on the Iberian Peninsula in Southwestern Europe. Featuring Cabo da Roca, the westernmost point in continental Europe, Portugal borders Spain to its north and east, with which it share ...
with one of the more strict legislations in the world and the US with one of the more flexible ones. In spite of these differences, both countries have similar unemployment rates which undermines the argument considering that EPL has any effect on unemployment. Instead, the authors claim that EPL does affect two other variables: job flows and unemployment duration. EPL would reduce job flows (from employment to unemployment: employers are less willing to fire, given that they must pay indemnification to workers) therefore reducing unemployment but would increase unemployment duration, increasing the unemployment rate. These two effects would neutralize each other, explaining why overall, EPL has no effect on unemployment. Nickell (1997) arrived to similar conclusions when stating that labor market rigidities that do not appear to have serious implications for average levels of unemployment included strict employment protection legislation and general legislation on labor market standards. Among those that have found evidence suggesting that EPL increases unemployment are Lazear (1990). The author argued that mandated severance pay seemed to increase unemployment rates. His estimates suggested that an increase from zero to three months of severance pay would raise the unemployment rate by 5.5 percent in the United States.


On employment

Lazear (1990) once again argues he has evidence suggesting that EPL reduces the
employment-to-population ratio Employment-to-population ratio, also called the employment rate, is a statistical ratio that measures the proportion of a country's working age population (statistics are often given for ages 15 to 64) that is employed. This includes people that ...
. In his article he claims that the best estimates suggest that moving from no required
severance pay Severance may refer to: Arts and entertainment * ''Severance'' (film), a 2006 British horror film * ''Severance'' (novel), a 2018 novel by Ling Ma *''Severance'', a 2006 short-story collection by Robert Olen Butler * ''Severance'' (TV series), ...
to three months of required severance pay to employees with ten years of service would reduce the employment-population ratio by about one percent. In the
United States The United States of America (USA), also known as the United States (U.S.) or America, is a country primarily located in North America. It is a federal republic of 50 U.S. state, states and a federal capital district, Washington, D.C. The 48 ...
that would mean over a million jobs. Lazear argues that the young could bear a disproportionate amount of the burden. To the contrary, Bertola and Bentolila (1990) found evidence supporting the idea that firing costs have a larger effect on firms' propensity to fire than to hire, and therefore (slightly) increase average long-run
employment Employment is a relationship between two party (law), parties Regulation, regulating the provision of paid Labour (human activity), labour services. Usually based on a employment contract, contract, one party, the employer, which might be a cor ...
.


On wages

Several authors have found that EPL has significant effects on wages. As stated by Lazear (1990), in a perfect labor market, severance payments can have no real effects as they can be undone by a properly designed labor contract. Leonardi and Pica (2006) found evidence supporting this claim. They suggest that in the case of
Italy Italy, officially the Italian Republic, is a country in Southern Europe, Southern and Western Europe, Western Europe. It consists of Italian Peninsula, a peninsula that extends into the Mediterranean Sea, with the Alps on its northern land b ...
an EPL reform in 1990 had as effect to reduce entry wages by 6 percent, implying that firms tend to transfer the increase in the cost of firing (due to EPL) onto workers. In fact, in their study they find that 25 percent of the firing cost was shifted onto lower wages in the case of Italy. Similarly, Brancaccio, Garbellini, and Giammetti (2018) found that EPL reductions have no significant links with real GDP growth whereas they are significantly correlated with wage share reductions.


On firm efficiency and profits

In principle the effects on profits are ambiguous. Because of EPL, firms engage themselves in labour hoarding practices, which lead them to employ a lower quantity of workers during upswings, while keeping inefficient levels of employment in downturns. For a given level of wages, this loss of productive
efficiency Efficiency is the often measurable ability to avoid making mistakes or wasting materials, energy, efforts, money, and time while performing a task. In a more general sense, it is the ability to do things well, successfully, and without waste. ...
would result in lower average
profit Profit may refer to: Business and law * Profit (accounting), the difference between the purchase price and the costs of bringing to market * Profit (economics), normal profit and economic profit * Profit (real property), a nonpossessory inter ...
s. On the other hand, if firms operated in a context of efficiency wages, by inducing more stable relationships with the workers and reducing their job and income insecurity, EPL could allow them to pay lower wages, without reducing the effort provided by the labour force employed, with beneficial effects on profits.


On product market regulation

There appears to be agreement among economists on the positive
correlation In statistics, correlation or dependence is any statistical relationship, whether causal or not, between two random variables or bivariate data. Although in the broadest sense, "correlation" may indicate any type of association, in statistics ...
between product market and employment
regulation Regulation is the management of complex systems according to a set of rules and trends. In systems theory, these types of rules exist in various fields of biology and society, but the term has slightly different meanings according to context. Fo ...
. Although employment protection legislation is only one aspect of the wide range of regulatory interventions in the
labour market Labour or labor may refer to: * Childbirth, the delivery of a baby * Labour (human activity), or work ** Manual labour, physical work ** Wage labour, a socioeconomic relationship between a worker and an employer ** Organized labour and the labou ...
, Nicoletti et al. (2000) find evidence suggesting that, across countries, restrictive regulatory environments in the product market tend to be associated with restrictive employment protection policies. They claim that the indicators presented in their paper are closely related, with a statistical
correlation In statistics, correlation or dependence is any statistical relationship, whether causal or not, between two random variables or bivariate data. Although in the broadest sense, "correlation" may indicate any type of association, in statistics ...
of 0.73 ( significant at the 1% level). In other words, according to these results, restrictive product market regulations are matched by analogous EPL restrictions to generate a tight overall regulatory environment for firms in their product market as well as in the allocation of labour inputs. The strong correlation between regulatory regimes in the product market and EPL also suggests that their influence may have compounded effects on labour market outcomes, making regulatory reform in only one market less effective than simultaneous reform in the two markets. Kugler and Pica (2003) find similar results in the case of the Italian economy. They present a matching model which illustrates how
barriers to entry In theories of Competition (economics), competition in economics, a barrier to entry, or an economic barrier to entry, is a fixed cost that must be incurred by a new entrant, regardless of production or sales activities, into a Market (economics) ...
in the product market (product market regulation) mitigate the impact of labor market deregulation, (that is, mitigate the effects of a reduction in the strictness of EPL). In the author's opinion, this means that there are economic complementarities between labor and product market policies in their model, in the sense that the effectiveness of one policy depends on the implementation of the other policy. Thus, an important implication of their model is that labor market deregulation will be less effective in the presence of heavier regulations of entry. Similar results are obtained by Koeniger and Vindigni (2003).


On hours per worker

Whereas EPL may have not a significant effect on unemployment, strict EPL gives incentives to the firms to resort to other sources of
flexibility Stiffness is the extent to which an object resists deformation in response to an applied force. The complementary concept is flexibility or pliability: the more flexible an object is, the less stiff it is. Calculations The stiffness, k, of a ...
like overtime, which, as shown by Abraham and Houseman (1994), indeed tends to be used much more in Continental European countries, where the variability of hours per worker is significantly higher than in the Anglo-Saxon
labour market Labour or labor may refer to: * Childbirth, the delivery of a baby * Labour (human activity), or work ** Manual labour, physical work ** Wage labour, a socioeconomic relationship between a worker and an employer ** Organized labour and the labou ...
s.


Economic theory

In economic theory, several authors have argued that employment protection can be desirable when there are frictions in the working of markets. For example, Pissarides (2001) and Alvarez and Veracierto (2001) show that employment protection can play an important role in the absence of perfect insurance markets. Schmitz (2004) argues that constraining contractual freedom by legislating employment protection can be welfare-enhancing when principal-agent relationships are plagued by asymmetric information.


See also

*
Labour law Labour laws (also spelled as labor laws), labour code or employment laws are those that mediate the relationship between workers, employing entities, trade unions, and the government. Collective labour law relates to the tripartite relationship be ...
*
Labour market Labour or labor may refer to: * Childbirth, the delivery of a baby * Labour (human activity), or work ** Manual labour, physical work ** Wage labour, a socioeconomic relationship between a worker and an employer ** Organized labour and the labou ...
* Labour market flexibility *
Microeconomics Microeconomics is a branch of economics that studies the behavior of individuals and Theory of the firm, firms in making decisions regarding the allocation of scarcity, scarce resources and the interactions among these individuals and firms. M ...
* Occupational licensing *
Unemployment Unemployment, according to the OECD (Organisation for Economic Co-operation and Development), is the proportion of people above a specified age (usually 15) not being in paid employment or self-employment but currently available for work du ...
* Important publications in labour economics * Job security


Notes

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References

*KG Abraham and SN Houseman (1994): Does Employment Protection Inhibit Labour Market Flexibility? Lessons from Germany, France and Belgium. In Blank R.M. (ed.) Social Protection versus Economic Flexibility: Is there a trade-off?. The University of Chicago Press, (1994) * Andrea Barone (2001): Employment protection legislation: a critical review of the literature. Taken from www.cesifin.it * Samuel Bentolila and Giuseppe Bertola (1990): Firing Costs and Labour Demand: How Bad is Eurosclerosis?. The Review of Economic Studies, Vol. 57, No. 3. (Jul., 1990), pp. 381–402. * Olivier Blanchard and Pedro Portugal (2000): What hides behind an unemployment rate: Comparing Portuguese and U.S. labor markets. The American Economic Review, Vol. 91, No. 1. (Mar., 2001), pp. 187–207. * Winfried Koeniger and Andrea Vindigni (2003): Employment Protection and Product Market Regulation. IZA WZB Economics Seminar Series. July 28, 2003. Downloadable * Adriana Kugler and Giovanni Pica (2003): Effects of Employment Protection and Product Market Regulations on the Italian Labor Market. Journal of Economic Literature, November 12, 2003, p. 7. Downloadable * Edward Lazear (1990): Job Security Provisions and Employment. Quarterly Journal of Economics, 105(3): 699–726. * Marco Leonardi and Giovanni Pica (2006): Effects of Employment Protection Legislation on Wages: a Regression Discontinuity Approach. IZA Working Papers. Downloadable * Stephen Nickell (1997): Unemployment and Labor Market Rigidities: Europe versus North America. The Journal of Economic Perspectives, Vol. 11, No. 3. (Summer, 1997), pp. 55–74. * Giuseppe Nicoletti, Stefano Scarpetta and Olivier Boylaud (2000): Summary Indicators of Product Market Regulation with an Extension to Employment Protection Legislation. OECD Economics Department Working Papers NO. 226, April 13, 2000, p. 51. Downloadable Labour law Unemployment