DP1101 Quitting Externalities, Employment Cyclicality and Firing Costs

Author(s): Alison L Booth, Gylfi Zoega
Publication Date: December 1994
Keyword(s): Employment Cyclicality, Human Capital, Quitting Externalities, Redundancy Payments
JEL(s): E32, J23, J24, J41
Programme Areas: Human Resources
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1101

This paper derives a model in which workers have firm-specific and industry-specific skills, and in each period there is a non-zero probability that a worker quits. This makes the private discount factor, used by firms in making decisions about hiring and training new workers and firing existing ones, higher than the social one. As a consequence, not only do firms underinvest in training but employment becomes too cyclical. Firms are too quick to dispose of their human capital in a cyclical downturn because it is of less value to them than it is to society. This provides a rationale for state-mandated redundancy payments as a second-best remedy to overcome the market failure.