The Effect of Labor Market Regulations on Educational Attainment

Abstract

This paper develops a theoretical and an empirical model to study the effect of higher employment protection on investments in tertiary education. The mechanism driving this link is the effect of employment protection on worker flows. Worker flows (which are synonymous with job flows in my model), are significantly lower with firing taxes, leading to fewer vacancies available per unemployed worker (also referred to as market tightness). This reduces the probability of finding a job and therefore lowers the expected return to education. In equilibrium, with high firing taxes, only the highest ability individuals invest in costly education. I test my model using panel data for more than a 100 countries over the period 1970-2005. Using data from the World Bank as well as from the Barro-Lee dataset on education, I find that, controlling for other factors, more flexible labor markets (or those with lower employment protection) are associated with relatively higher tertiary enrollment and graduation rates than more rigid markets.