Reforming Labor Market Institutions: Unemployment Insurance and Employment Protection

Abstract

This paper explores the characteristics of both optimal and actual unemployment insurance and employment protection. It then sketches potential paths for reforms in both rich and middle-income countries. It reaches three main conclusions: There is a role for both state-provided unemployment insurance and employment protection. In rich countries, one challenge is to combine unemployment insurance with strong incentives for the unemployed to take jobs. Financial incentives are unlikely to be enough at the low end of the wage scale. The other challenge is to redefine employment protection by reducing administrative constraints and judicial intervention, and relying more on financial incentives. In middle-income countries, the main challenge is to move from the current system of high severance payments and employment protection to a system of state-provided unemployment benefits and lower severance payments.