Firing Costs and Decoupling of Technological Invention and Post-invention Investments

Abstract

We show that employment protection laws, which increase firing costs, decouple invention and post-invention investment by reducing the coordination benefits of collocation. The decoupling played a significant role in US employment decline and jobless growth, the vertical and geographical disintegration of firm activities, and underinvestment relative to Tobin’s Q. Technological inventions lead to employment growth, but employment protection laws almost fully negate this positive effect, especially in fast-changing and high-offshore industries and for radical inventions. We find limited effects on firm revenue and profits, as firms bypass increased firing costs through capital substitution and increased JV and alliance activities, driven in part by collaborations with foreign partners. Our findings suggest labor market flexibility as a critical link between invention and firm growth dynamics and question the efficacy of technology-led revival of the US manufacturing employment without the accompanying labor market reforms.