Do Employment Protections Reduce Productivity? Evidence from U.S. States

Theory predicts that mandated employment protections may reduce productivity by distorting production choices. Firms facing (non-Coasean) worker dismissal costs will curtail hiring below e¢ cient levels and retain unproductive workers, both of which should a¤ect productivity. These theoretical predictions have rarely been tested. We use the adoption of wrongful-discharge protections by U.S. state courts over the last three decades to evaluate the link between dismissal costs and productivity. Drawing on establishment-level data from the Annual Survey of Manufacturers and the Longitudinal Business Database, our estimates suggest that wrongfuldischarge protections reduce employment ‡ows and …rm entry rates. Moreover, analysis of plant-level data provides evidence of capital deepening and a decline in total factor productivity following the introduction of wrongful-discharge protections. This last result is potentially quite important, suggesting that mandated employment protections reduce productive e¢ ciency as theory would suggest. However, our analysis also presents some puzzles including, most significantly, evidence of strong employment growth following adoption of dismissal protections. In light of these puzzles, we read our …ndings as suggestive but tentative. Keywords: Dismissal Costs, Employment Fluctuations, Entry and Exit, Labor Productivity, TFP, Entrepreneurship. JEL Classi…cation: J11, J21, J31, J61. E-mails: [email protected], [email protected] and [email protected]. The research in this paper was conducted while the authors were Special Sworn Status researchers of the U.S. Census Bureau at the Boston Census Research Data Center (BRDC). Support for this research from NSF grant (ITR-0427889) is gratefully acknowledged. Research results and conclusions expressed are those of the authors and do not necessarily re‡ect the views of the Census Bureau. This paper has been screened to insure that no con…dential data are revealed. We are grateful to seminar participants at the IZA Conference on Employment Protection and Labor Markets, the Census Bureau RDC Conference, MIT, NBER Labor and Productivity Groups, SOLE, and AEA and, especially, to Daron Acemoglu, Josh Angrist, Giuseppe Bertola, Björn Brügemann, and Paul Oyer for their comments. Autor acknowledges generous support from the National Science Foundation (CAREER SES-0239538) and the Alfred P. Sloan Foundation. Kugler acknowledges support from a GEAR grant from the University of Houston.