04 September 2016

Regulations in 'rigid' labour markets are less likely to be enforced

How difficult is it to fire a worker in different countries?

To answer this question, most social scientists have created many indicators that capture the conditions, costs and uncertainty associated with firing an employee.

For instance the OECD Employment Protection Legislation (EPL) index measures "the procedures and costs involved in dismissing individuals or groups of workers and the procedures involved in hiring workers on fixed-term or temporary work agency contracts"


The determinants and consequences of EPL

This index is then used in statistical analysis to assess the impact of EPL on economic outcomes, such as unemployment, or to identify the determinants of EPL reforms, for instance partisanship.

The conventional wisdom is that EPL has adverse economic consequences (studies by IMF and OECD, Layard, Botero and others), but the stability of the findings to different specification has been contested (for instance see work by Baker, Avdagic and others).


Employment Protection Legislation: rules versus enforcement

For a long time a more obvious problem has been that legal restrictions on firing can only be expected to have any effects on labour market performance if the legislation is actually enforced on the ground.

The issue here is not so much that employment protection legislation might not enforced (which is likely) but more importantly that it might be enforced to varying degrees in different countries in ways that we cannot observed.


New database on enforcement

This shortcoming is now being partly addressed in recent research by Kanbur and Ronconi published in the Centre for Economic Policy Research.

In a shorter version of the paper they have published in VoX they explain how they created a new indicator of enforcement that combines both inspections and penalties.


Their results are interesting in at least two respects 

First, once they control for their measure of enforcement in a statistical analysis of the determinant of labour market performance, EPL no longer has a statistically significant adverse effect for most measures of performance. In other words, labour market regulations do not in fact seem to have a consistent effect on labour market outcomes.  

Second, they show that countries with more stringent EPL have lower enforcement levels, which then makes it difficult to know which country's labour market really is more 'rigid'. This is shown in the figure below that plots a de jure employment index on the horizontal axis and their enforcement index on the vertical axis.


Interpreting the figure: some country examples

The ranking should be interpreted as follows: countries which are lower on the scale have higher ranking and hence more protective institutions or more enforcement. 

Thus for instance, while Canada and Denmark have among the lowest ranking in de jure employment protection (they are not in the top 150 countries), they rank really high in terms of enforcement (in top 25). By contrast, France and Spain score high on EPL but do not rank well in terms of enforcement: their stringent regulations are not well-enforced compared to many other countries.


Figure: Enforcement and labour law

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