DP7806 Employment Protection, Technology Choice, and Worker Allocation

Author(s): Eric J Bartelsman, Joris de Wind, Pieter A. Gautier
Publication Date: May 2010
Keyword(s): employment protection, Information and Commications Technology, search, sectoral allocation
JEL(s): J65, O38
Programme Areas: Labour Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=7806

Using a country-industry panel dataset (EUKLEMS) we uncover a robust empirical regularity, namely that high-risk innovative sectors are relatively smaller in countries with strict employment protection legislation (EPL). To understand the mechanism, we develop a two-sector matching model where firms endogenously choose between a safe technology with known productivity and a risky technology with productivity subject to sizeable shocks. Strict EPL makes the risky technology relatively less attractive because it is more costly to shed workers upon receiving a low productivity draw. We calibrate the model using a variety of aggregate, industry and micro-level data sources. We then simulate the model to reflect both the observed differences across countries in EPL and the observed increase since the mid-1990s in the variance of firm performance associated with the adoption of information and communication technology. The simulations produce a differential response to the arrival of risky technology between low- and high-EPL countries that coincides with the findings in the data. The described mechanism can explain a considerable portion of the slowdown in productivity in the EU relative to the US since 1995.