Turning Pink Slips into Red Tape: The Unintended Effects of Employment Protection Legislation

This paper presents evidence on the link between employment protection legislation (EPL), such as mandated severance packages for fired workers, and the rate of unemployment in a cross-country panel data set of OECD countries from 1990-2013. We use both a traditional fixed effects panel specification with lags of the policy variable, and also a unique structural panel vector autoregression (PVAR) method to determine the long-run dynamic interaction between employment protection legislation and unemployment. We confirm that a tightening of EPL for permanently employed workers causes a significant and persistent increase in unemployment, but the effect is only apparent at long lag lengths, some 2-5 years after the law has been implemented. We find weaker evidence that employment protection legislation specific to temporary worker contracts also increases unemployment. ∗University of Mississippi Department of Economics, 341 Holman Hall, University, MS, 38677, [email protected] †University of Mississippi Department of Economics, 229 North Hall, University, MS, 38677, [email protected]