The European Journal of Comparative Economics

ISSN: 1824-2979

EJCE Year: 2012, April. Volume: 9 - Issue: 1

How Do Firing Costs Affect Innovation and Growth when Workers' Ability is Unknown? Employment Protection as a Burden on a Firm's Screening Process

by Binyamin Berdugo ; Sharon Hadad

Start page: 3 - End page: 30

Keywords: Severance Payments; Firing Costs; Screening Costs; Specialization; Growth

Jel code: J2; O40; F16; K31

Abstract:

This paper analyzes the implication of employment protection legislation on a firm's screening process. We present a model in which human-capital-intensive firms (high-tech firms) with imperfect information about their workers' type attempt during a trial period to identify those incompetent workers they will subsequently dismiss. However, employment protection measures place a burden on this screening process thereby motivating innovators to embark on medium-tech projects which are more flexible in their human capital requirements. As such, employment protection legislation distorts the pattern of specialization in favor of medium-tech firms over high-tech firms and consequently slows down the process of economic growth. The results of the paper are consistent with documented data on Europe versus US productivity growth and specialization patterns.

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