Employment Protection and Unemployment in an Efficiency Wage Model


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.

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