Product Market Regulation, Firm Selection and Unemployment

This paper analyzes the effect of Product Market Regulation (PMR) on unemployment in a search model with heterogeneous multiple-worker firms. In our setup, PMR modifies the distribution of firm productivities, thereby affecting the equilibrium rate of unemployment. We distinguish between PMR related to firms' startup costs and PMR that generates recurrent fixed costs. The latter type of PMR decreases the rate of unemployment through our novel selection effect, while they increase it through the conventional competition effect. In contrast, higher startup costs always raise the rate of unemployment. We propose econometric evidence consistent with the unemployment effect of sunk versus recurring PMR-induced costs.