Employment protection and country's attractiveness: a more ambiguous relationship than is usually assumed

This paper argues that being constrained by a strict employment protection legislation (EPL) is not as terrible for domestic firms as is usually assumed. Indeed, the markets concerned with international trade are oligopolistic. In such markets, a firm located in a country with a strict EPL suffers from a lack of production flexibility. However, because of this, that same firm may become a Stackelberg leader, which may turn out to be beneficial. Strategic interactions, therefore, cause the profitability of firms to become disconnected from their ability to adjust to demand fluctuations. Moreover, although they are unable to adjust their total output, firms located in the country with a strict EPL can allocate their sales across the different markets. This allocation flexibility, therefore, causes the adaptation of firms to demand fluctuations to be disconnected from their level of production flexibility. Unfortunately, allocation flexibility weakens the strategic advantage related to quantity commitment. The analysis of the impact of EPL on the attractiveness of the country then becomes more complex than generally alleged. However, this paper shows that, for a wide range of values of model parameters, a strict EPL does not deter investments.