firing costs


Firing costs are often blamed for unemployment. This paper investigates this widespread
belief theoretically. The main points are two. First, firing costs are introduced in an effi-
ciency wage model to capture their effects on employment though wages Second, dismissal
conflicts are modeled explicitly and their cost is derived. These two elements are put together
and linked. In this way, the model integrates very different views put forward by different
economists depending on the model used: the view that firing costs reduce employment,
the idea that firing costs are neutral on employment if markets are perfect and complete
and, also the possibility that firing costs are chosen voluntarily by firms. Modeling firing
costs in a context where worker effort is not perfectly observable implies that a double moral
hazard problem could arise. Whenever firms face a redundancy, they tend to use disciplinary
dismissals in order to avoid paying firing costs. Similarly, workers will then tend to deny
any disciplinary case to get a compensation. My claim in this paper is that the resolution
of this problem by a third party will be imperfect given the information problem. This will
in turn imply that disciplinary dismissals will not be costless and therefore firing costs will
have a negative effect on aggregate employment. Some policy implications are discussed.
In particular, it is found that the solution to the problem does not necessarily imply the
elimination of firing costs.

Year of Publication
Date Published
Publication Language
Citation Key
Guell, M. (2000). Employment Protection and Unemployment in an Efficiency Wage Model. Retrieved from (Original work published 03/2000AD)
Working Papers

Job security provisions are commonly invoked to explain the high and persistent European
unemployment rates. This belief has led several countries to reform their labor markets and
liberalize the use of fixed-term contracts. Despite how common such contracts have become
after deregulation, there is a lack of quantitative analysis of their impact on the economy. To
fill this gap, we build a general equilibrium model with heterogeneous agents and firing costs
in the tradition of Hopenhayn and Rogerson (1993). We calibrate our model to Spanish data,
choosing in part parameters estimated with firm-level longitudinal data. Spain is particularly
interesting, since its labor regulations are among the most protective in the OECD, and both
its unemployment and its share of fixed-term employment are the highest. We find that fixedterm
contracts increase unemployment, reduce output, and raise productivity. The welfare
effects are ambiguous.

Year of Publication
Date Published
Publication Language
Citation Key
Alonso-Borrego, C., Fernandez-Villaverde, J., & Galdon-Sanchez, J. (2004). Evaluating Labor Market Reforms: A General Equilibrium Approach. Retrieved from (Original work published 05/2004AD)
Working Papers