Unemployment
Firing cost effects

Mandatory firing costs were introduced in many European countries from the late 1950s through to the early 1970s. These firing restrictions have been blamed by some commentators for the high levels of European unemployment since the first oil shock of 1973. The fact that US employment has been relatively less protected by state regulation, and US unemployment since 1973 has been lower than in Europe, has reinforced the popular view that firing costs contribute to the high levels of European unemployment.

The model developed in Discussion Paper No. 1096 by Research Fellow Alison Booth, examines the relationship between firing costs and unemployment in a simple two-period model with uncertainty. Where there are long-term employment relationships, and where risk-averse workers and risk-neutral firms bargain over wages and firing costs, average unemployment is unlikely to be affected by statutory firing costs, although firms' profits will decline if the statutory level exceeds the bargained level. In a unionized sector with no bargaining over firing costs, the presence of statutory firing costs reduces employment distortions associated with trade unions. Where there are no gains to employers from long-term labour relationships, however, the introduction of mandated firing costs will be associated with a higher incidence of temporary employment contracts and short-term jobs.

The Unemployment Implications of Mandatory Firing Costs
Alison L Booth

Discussion Paper No. 1096, December 1994 (HR)