LIUC
The European Journal of Comparative Economics
ISSN: 1824-2979
LIUC
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

Binyamin Berdugo ; Sharon Hadad

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Start page: 3 - End page: 30

Keywords:
Severance Payments, Firing Costs, Screening Costs, Specialization, Growth
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.

Jel code: J2
Jel code: O40
Jel code: F16
Jel code: K31
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