Abstract
Purpose This paper aims to weigh the restrictions to job creation imposed by labor market imperfections with respect to financial market imperfections. The authors want to see which restriction is more severe, and thus assess which is more powerful in creating permanent employment if it were removed. Design/methodology/approach A structural estimation is performed. The policy rules of the dynamic programming model are integrated into a simulated maximum likelihood procedure by which the model parameters are recovered. Data come from the CBBE (Balance Sheet data from the Bank of Spain). Identification of key parameters comes mainly from the observation of debt variation and sluggish adjustment to permanent labor. Findings Long-run permanent employment increases up to 69% when financial constraints are removed, whereas permanent employment only increases up to 54% when employment protection or firing costs are eliminated. The main finding of this paper is that the long-run expansion of permanent employment is larger when financial imperfections are removed than when firing costs are removed, even when there are important wage increases that moderate these employment expansions. Social implications The removal of firing costs has been suggested by several economists as a result of the analysis of labor market imperfections. These policies, however, face the strong opposition of labor unions. This paper shows that the goals of permanent job creation can be accomplished without removing employment protection but by means of enhancing financial access to firms. Originality/value The connection between financial constraints and employment has been studied in recent years, motivated by the Great Recession. However, there is no assessment of how financial and labor market imperfections compare with each other to restrict permanent job creation. This comparison is crucial for policy analysis. This study is an attempt to fill out this gap in the economic literature. No previous research has attempted to perform this very important comparison.
Highlights
When payroll variations are costly and financial constraints are tight, firms are strongly discouraged from hiring workers
Capital accumulation and permanent job creation are restricted by a limited ability to use external finance and by the costly firing of permanent workers
A comparative evaluation of two counterfactual scenarios reveals that relaxing financial constraints increases long-run permanent employment by 69% while removing firing costs increases long-run permanent employment by up to 54%
Summary
When payroll variations are costly and financial constraints are tight, firms are strongly discouraged from hiring workers Both financial and labor market imperfections restrict employment expansion. The theoretical framework of this article is a neoclassical dynamic model of investment on the lines of Jorgenson (1963), with adjustment costs to capital as in Lucas and Prescott (1971), extended to allow for liquidity constraints and bankruptcy, as well as labor hiring and firing decisions. This framework is suitable for evaluating the dynamics of capital, debt and two types of labor under the elimination of firing costs and the elimination of financial constraints. The main implication of this finding is that the elimination of financial constraints can play a very important role in designing employment policies as it can create more jobs than just removing firing costs
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