Is labour rigidity harming Europe's competitiveness? The effect of job protection on the pattern of trade and welfare

Abstract

We develop a model to analyse the implications of firing costs on international specialization. To avoid paying the firing cost, the country with a rigid labor market will tend to produce relatively secure goods, at a late stage of their product life cycle. An international product cycle emerges where new goods are first produced in the low firing cost country and then move to the high firing cost country. An increase in firing costs in the high firing cost country lowers welfare there and increases welfare in the low firing cost country. It also narrows the range of goods produced by the high firing cost country, biasing its specialization towards more mature goods.