The Reallocation of Employment and the Role of Employment Protection Legislation

Output and productivity is affected by the allocation of workers between firms, industries and occupations as well as by total employment. Policy affects the ability of markets to carry out the reallocation of factors, and the aim of facilitating this process may involve reducing restraints on the ability of firms to hire and fire labour. This is the connection between the reallocation of labour and Employment Protection Legislation (EPL). This paper addresses two questions: first, is there any evidence that the tightness of a country's EPL does affect the speed with which labour is reallocated? Second, do differences in reallocation speed matter quantitatively for the country's welfare? To address the first question, we define five alternative measurements of reallocation and apply these measures to our sample of ten of the largest OECD countries, disaggregated into 20 industries, over the period of 18 years, 1971-1988. The results provides some support for the idea of a link between EPL and the speed of labour reallocation. On the second question, some preliminary investigations show that this may not be a trivial issue. The qualitative answer is clear: an economy which is slow in moving labour from low to high productivity firms will produce less output and exhibit lower aggregate productivity growth; a simple model suggests that the magnitude of this effect may be significant.