Employment Protection Legislation, Capital Investment and Access to Credit: Evidence from Italy

Abstract

This article estimates the causal impact of dismissal costs on capital deepening and productivity, exploiting a reform that introduced unjust-dismissal costs in Italy for firms below 15 employees, leaving firing costs unchanged for larger firms. We show that the rise in firing costs induced an increase in the capital-labour ratio and a decline in total factor productivity in small firms relative to larger firms. Our results indicate that capital deepening was more pronounced at the low-end of the capital distribution -where the reform hit arguably harder -and among firms endowed with a larger amount of liquid resources. We also find that stricter Employment Protection Legislation (EPL) raised the share of high-tenure workers, which suggests a complementarity between firm-specific human capital and physical capital in moderate EPL environments.If dismissal protections cannot be undone by Coasean bargaining, theory predicts that employment protection legislation (EPL) acts as a tax on both hiring and firing, reducing accessions and separations with an ambiguous final effect on the employment level. The reason is that firing costs provide incentives to retain workers whose wage exceeds their productivity during bad times and not to hire workers whose wage lies below their productivity during good times (Bentolila and Bertola, 1990). While there is a large body of evidence confirming this theoretical prediction (see the recent review by Skedinger, 2011), less is known about the impact of dismissal costs on other firm level outcomes, as capital deepening and productivity.The theoretical predictions of the impact of EPL on capital deepening are in fact ambiguous. In competitive models with no financial and labour market frictions, an increase in EPL is expected to raise the cost of labour and induce capital-labour substitution, distorting production choices and reducing allocative efficiency (Autor et al., 2007); in the long-run firms can change their production techniques and adopt more capital-intensive technologies (Caballero and Hammour, 1998;Alesina and Zeira, 2006;Koeniger and Leonardi, 2007). On the contrary, in models with labour market frictions and wage bargaining, stricter EPL exacerbates the 'hold-up' problem typical of investment decisions and reduces the stock of capital per worker (Bentolila and Dolado, 1994;Garibaldi and Violante, 2005). However, the relationship between EPL and capital intensity can turn positive if physical capital and firm-specific human

Regulation, Institutions and Aggregate Investment: New Evidence from OECD Countries

“…Using a panel of European firms, Cingano et al (2010) find that more stringent EPL reduces investment per worker and capital per worker. By contrast, focusing only on Italian firms, Cingano et al (2015) show that the introduction of unjust-dismissal costs raises the capital-to-labour ratio in firms with less than 15 employees, compared to larger firms. Finally, according to Cette et al (2016), at the sector level 5 , more stringent EPL has a positive effect on non-ICT capital, a nonsignificant effect on ICT capital and impacts negatively R&D capital…”

Employment protection legislation and entrepreneurial activity

“…Extant research focuses largely upon the macro employment effects of employment protection (Holt and Hendrickson, 2017;Kahn, 2010). Böckerman et al (2018) (micro level), Cingano et al (2016) and Griffith and Macartney (2014) (meso level) are some notable exceptions. Empirical findings are inconclusive regarding the effects of composite EPL indicators on unemployment, employment and self-employment rates.…”

The quantification of structural reforms in OECD countries: A new framework

“…A rise in capital may be related to a correction of an earlier downturn and that the introduction of more stringent firing regulations followed a rise of the capital-to-labour ratio (Autor et al 2007). For Italian firms, estimation results show that the introduction of unjust-dismissal costs raises the capital-to-labour ratio in firms with less than 15 employees, compared to larger firms (Cingano et al, 2015). …”