Employment Protection, Exit, and Macroeconomic Dynamics

The literature on employment protection has largely ignored the influence that such policies may have on macroeconomic dynamics. Also, the manner in which exit has been modelled heretofore may understate the effects of these policies. Finally, industrial subsidies to failing plants have largely been ignored as an important element of employment protection. To address these issues, I develop a general equilibrium model with close attention to the quantitative importance of the exit margin, and ask whether economies with different levels of employment protection respond differently to shocks. I find that steady-state policy analysis is adequate to capture the main welfare effects of these policies. Period length and the approach to exit are found to be important determinants of steady-state effects of dismissal costs. Dismissal costs are found to smooth the economy’s response to productivity shocks. Interestingly, this effect is irrespective of whether these shocks are positive or negative. Industrial subsidies, however, have no effect on short run macroeconomic dynamics. The exit margin is found not to be important for the dynamic behavior of the economy, even when changes in the determinants of exit are themselves part of the shock. JEL Codes: E32, J63, L51