Firing costs, misallocation, and aggregate productivity

Abstract

We study the impact of firing costs on aggregate total factor productivity (TFP) in a dynamic general-equilibrium framework where the evolution of establishment-level productivity is not invariant to the policy. Firing costs not only generate static factor misallocation, but also distort the selection of establishment’s growth by size, contributing to larger aggregate TFP losses. Numerical experiments indicate that firing costs equivalent to 5 year’s wages imply a reduction in TFP of more than 20%. Factor misallocation accounts for 20% of the productivity loss, whereas the remaining 80% arises from distorted selection in the productivity process.