Employment protection in industrialized countries: The case for new indicators

Abstract

The poor employment performance of European countries compared with that of the U.S. is often attributed to the strictness of employment protection in Europe. Many believe that differences in labour market regulations play an important role in explaining international differences in labour market outcomes. This argument clearly has strong implications for policy design. If tight rules governing employment protection are to be blamed for poor labour market performance, then conservative governments may reduce restraints on the ability of firms to hire and fire (by weakening trade unions and labour market regulations for example). This controversial proposition has generated a considerable literature and much debate. Theoretical models show that employment protection does tend to have a constraining effect on both layoffs and hirings, job creation and destruction, unemployment inflows and outflows, with the extent to which one effect dominates the other depending on the values of the parameters. It follows that the role played by employment protection in determining aggregate labour market outcomes is mainly an empirical question. However, the available empirical evidence on the relationship between employment protection and labour market performance is based on highly imperfect measures of the strictness of employment protection legislation (EPL).1 While considerable work – both theoretical and empirical – has been done on the subject, few studies have focused on how employment protection is measured. Previous research has circumvented measurement difficulties by using qualitative rankings of EPL stringency. But recent developments – notably ongoing reforms of employment protection in most countries and the expansion of non-standard forms of employment – have not only rendered existing information obsolete, they have also called into question the methodological basis of that empirical research.