Employment Protection Legislation and the Macroeconomy: Evidence from Brazil

Abstract

This paper exploits tenure-dependence in the design of employment protection legislation (EPL) to identify its equilibrium impacts. In our setting, Brazil, EPL applies after a three-month probationary period, incentivizing firms to terminate jobs at exactly 3 months. We develop a structural model in which firms learn about match quality to map this effect on job termination to equilibrium macroeconomic outcomes. We find that EPL without a probationary period leads to a 2.4 percent increase in unemployment and 3.3 percent decrease in output. However, introducing a probationary period completely negates these effects by effectively increasing the value of an initial match.