The Joint Design of Unemployment Insurance and Employment Protection: A First Pass

Abstract

Unemployment insurance and employment protection are typically discussed and studied in isolation. In this paper, we argue that they are tightly linked, and we focus on their joint optimal design in a simple model, with risk-averse workers, risk-neutral firms, and random shocks to productivity. We show that, in the “first best,”unemployment insurance comes with employment protection—in the form of layoff taxes; indeed, optimality requires that layoff taxes be equal to unemployment benefits. We then explore the implications of four broad categories of deviations from first best: limits on insurance, limits on layoff taxes, ex post wage bargaining, and ex ante heterogeneity of firms or workers. We show how the design must be modified in each case. Finally, we draw out the implications of our analysis for current policy debates and reform proposals, from the financing of unemployment insurance, to the respective roles of severance payments and unemployment benefits.