Unemployment and Employment Protection in a Unionized Economy with Search Frictions

Abstract

Abstract:In theoretical literature, the effects of employment protection on unemployment are ambiguous. Higher employment protection decreases job creation as well as job destruction. However, in most models, wages are bargained individually between workers and firms. Using a conventional matching model in which a monopoly union sets wages, I show that employment protection can unambiguously increase unemployment. Interestingly, I find that tightening the restrictions on redundancies and dismissals may even increase the probability of dismissal.Keywords: employment protection, search and matching models, unemployment, unions. JEL-Classification: J41, J64, J65, J68. Non-technical summaryRecently, employment protection has again become subject of intense political debate in Europe as the need for more flexible labor markets to reduce unemployment is discussed. For example, at the beginning of 2006, the French government passed the Contrat Première Embauche (CPE), implying that young workers could be fired without any prior notification or justification, which was not adopted in the face of massive public opposition. In Germany and other European countries, too, there has been an ongoing debate on the role that employment protection plays in reducing unemployment.In the economic literature, a clear link between employment protection and unemployment has not yet been established. From a theoretical point of view, stricter employment protection indeed reduces the incentive for job creation. However, it produces fewer dismissals, too. Hence, the effects on unemployment are ambiguous. Reviewing conventional theoretical findings, it becomes obvious that the results have been achieved using models in which wages are either exogenously given or individually bargained between firms and workers. This may be problematic as European labor markets are characterized by a high degree of collective bargaining. This paper develops a theoretical model that is able to account for this institutional factor. The basic idea in this context is that a monopoly union sets a perfectly egalitarian wage for each worker. The union maximizes the gain from employment compared with unemployment. An increase in restrictions on redundancies and dismissals improves the union's bargaining position. This causes the union to increase its wage claim. It can be shown that the additional labor costs may outweigh the additional dismissal costs and, hence, result in an increased probability of dismissal. As stricter employment protection still lowers the incentive for job creation, unemployment unambiguously rises. Nicht-technische ZusammenfassungIn neuerer Zeit wird die Diskussionüber Kündigungsschutz innerhalb Eu-

Reforming the labor market and improving competitiveness: an analysis for Spain using FiMod

“…Furthermore, two more theoretical remarks also seem in order. First, as has been shown in Stähler (2008), when talking about the effects of employment protection on unemployment in matching labor market frameworks, the bargaining structure itself matters. In the model at hand, we more or less follow the conventional approach.…”

“…It is not unlikely, however, that altering the bargaining game between unions and firms would alter our findings. For example, in the model by Stähler (2008), employment protection is indeed responsible for higher wage claims and higher unemployment rates. Second, Spain is characterized by a highly dual labor market consisting of (potentially less productive) insiders who enjoy a high degree of employment protection, and outsiders who have barely none.…”

“…In our model, we follow the standard approach in the matching literature. However, Stähler (2008) has shown that the bargaining game matters. And last but not least, modelling employment protection itself is quite a complicated issue and it probably deserves a more sophisticated modelling than simply implementing firing costs, the approach we followed in the model at hand.…”

Does Uncertainty of Firing Costs Reduce Hirings?

“…Marinescu (2008) also finds that in the UK when dismissed workers sue their ex‐employers for unfair dismissal, and are still unemployed, a higher unemployment rate has a positive impact on their probability of winning. On the other hand, Stähler (2007) shows that a reduction of judicial mistakes decreases unemployment as expected labor costs are lowered. But this result relies on an ‘average effect’ and it does not give any assessment of the impact of the variance of firing costs.…”

Temporary Contracts, Employment Protection, and Collective Bargaining

“…Stähler () uses a similar framework (in which wages are established by a monopoly union) to examine the consequences of an increase in the dismissal tax on job creation and destruction. In Stähler's model, more stringent employment protection policies reduce job creation and increase job destruction.…”