In countries where regulations that make dismissing someone from there job costly, employers tend to hire fewer workers when the economy picks-up, and employment tends to have smaller cyclical fluctuations. However, although this view is supported in cross country studies, recent work on firm-level employment indicates that while dismissals are much more regulated in Europe than in North America, rates of creation and destruction are remarkably similar. The usual response to these findings are that either the data is bad, or that firms and workers find ways round the regulations. However, in Discussion Paper 1519, Giuseppe Bertola and Richard Rogerson argue that these findings may be due to another factor.

The authors argument is that restrictions on job dismissals should lead to lower total job turnover, however this may not be the case if other institutional differences have the opposing effect. The important institutional difference between North American and European labour markets is that European wage negotiations are much more centralized. This centralistion, inspired by the 'equal pay for equal work' principle, causes a greater uniformity of wages. The paper finds that when institutional arrangements which affect employment and wages are considered with the regulations affecting job dismissals, the similarity of job turnover rates across labour markets need not have any implications for whether dismissal restrictions alone affect labour market allocations. However, it tends to suggest that labour markets with more stringent job security provisions tend to be characterised by relatively narrower wage variations. These findings have an important implication for policy making, in that wage compression and dismissal restrictions need to be implemented concurrently.

Institutions and Labour Reallocation
Giuseppe Bertola and Richard Rogerson