The impact of employment protection legislation on labour productivity in a general equilibrium matching model

Abstract

Abstract The standard analysis of the impact of EPL on labour market outcomes concentrates mainly on unemployment and job flows, disregarding possible effects on labour productivity. In this paper we make (a component of) labour productivity endogenous and analyze how the presence of a stringent protection legislation affects labour market in an equilibrium matching model with endogenous job destruction. In particular, in our study we imagine that an employed worker has to exert effort to produce and this generates disutility. Therefore, in this framework high labour productivity on one hand is costly for a worker in terms of disutility, and on the other hand might be beneficial in terms of lower job destruction. We find that high firing costs partially substitute high labour productivity in reducing job destruction and this, consequently, brings down the optimal level of productivity. Furthermore, the impact of EPL on unemployment is ambiguous but numerical exercises show unambiguously how higher firing restrictions reduce different measures of aggregate welfare. To some extent, the clear emergence of these results leads to interesting policy implications and, indeed, rationalizes the recent empirical evidence on the impact of EPL.