Dismissal Protection or Wage Flexibility

Due to increased technological change which lead to an increased demand for skilled workers, it becomes more and more difficult for low skilled workers to find a job. How should a society or political decision makers react? Recently, German politicians are engaged in a discussion about the introduction of combined and minimum wages as well as the reduction of employment protection mechanisms in order to increase the employment status of low skilled workers. However, a detailed macroeconomic examination of the effects of the above mentioned labor market policies in an environment which exhibits structural changes is still missing. Based on recent findings by Lindquist (2004) and Pierrard and Sneessens (2004), in this paper a dynamic general equilibrium model with equilibrium unemployment due to search an matching frictions is developed. Within this framework, the effects of labor market policies, in particular the introduction of minimum wages and firing costs, are analyzed. We show that a reduction of employment protection mechanisms are rather ineffective to increase the employment status of low skilled workers. However, it is shown that the higher a relative wage rigidity is the lower is low skilled employment