Friday, 6 March 2015

When overzealous job "protection" makes matters worse

I've gone on a bit in some recent posts about the necessity of efficient, flexible labour markets - noting (here, here and here) that the labour market tends to have huge gross flows with small net outcomes, and that it's easy, with good intentions but bad policy, to stuff up the flexible working of hiring and firing. I also found some evidence that our own labour market stacks up pretty well, when considered in long-run international perspective, in keeping unemployment down.

I'd said in that last post that "if you're concerned about unemployment, you're likely to be better off if you come up with some form of social protection that doesn't impede the flexible working of the labour market, rather than reaching for some "job protection" measure that makes it harder for employers to lay people off. Making it harder to fire, for example, makes it less attractive to hire in the first place". I didn't include anything concrete to back that up, but over at his blog Jim Rose happened to be writing about some recent local court decisions which appeared to be re-regulating employers' ability to lay off staff (his two articles are here and here), and as part of his argument he'd found this.

Isn't that neat? There's a clear* link between how tightly protected existing jobs are, and how long people are stuck in unemployment before they get their next one - with the best of intentions, policymakers trying to make the labour market more secure from an employee's perspective have produced a completely counterproductive outcome. It's good to know that again our own labour market shows up to international advantage, with relatively low long-term unemployment and indeed even lower long-term unemployment than you'd expect from a country with our level of job protection. Australia scrubs up pretty well, too.

I asked Jim where the chart came from, and he pointed me to the source, a June '14 article in the IMF's Finance & Development publication profiling the career of Christopher Pissarides, who won the Nobel prize in economics for his work on labour markets and unemployment. It's a good read. From a policy point of view, the bottom line is
“protect workers, not jobs.” Trying too hard to protect existing jobs through excessive restriction of dismissals can stop the churning of jobs that is necessary in a dynamic economy. It is better to protect workers from the consequences of joblessness through unemployment benefits and other income support—accompanied by active policies to get the unemployed back to suitable jobs before their skills and confidence deteriorate
Incidentally, if Jim is right that our Employment Court "stands apart from the modern labour economics of human capital and job search and matching as well as the modern theory of entrepreneurial alertness, and the market as a discovery procedure and an error correction mechanism", maybe there's a case for it to sit with a lay member who knows something about labour economics. The High Court sits with an experienced economist, when there are major competition or regulation cases, and it's a system that works well.

*I said 'clear' originally but two commenters over at The Dismal Science site said it didn't look at all clear to them, and they've got a good point. I did a rough and ready regression based on eyeball estimates of the data, and while there is a statistically significant link -  a 1 point increase in the index is associated with a 3.5 month increase in duration of unemployment - it's not a strong one, accounting for only about 25% of the variance in the data. "Clear' link overstates things: there's a lot more going on as well. I'd guess a big part is countries varying a lot in the effectiveness of their 'active' labour market policies. (Updated March 17)


  1. Interesting idea about having an economist sit on the employment Court as a lay member, interesting idea indeed. I will follow it up.

  2. Hi Donal,

    I've just caught up with this post and it's on a topic I think deserves much study.

    Chris Pissarides made a similar point to yours at his retirement lecture at the LSE - that the labour market regulation should above all remove impediments to hiring.

    That made me think carefully as it went against my intuition, but Chris has a deservedly high reputation.

    I'm inclined to the Adam Smith view that employers should pay a living wage (and that implies a similar unemployment benefit level from the default employer, the government) rather than workers relying on WFF, EITC etc. Of course, this implies the owners of the most marginal businesses should devote their efforts elsewhere. My thinking on that remains fluid.

    My response to the graph you present, though, is that all or nearly all of the countries to the right (although the political left) of NZ may have longer spells of unemployment for those who lose their jobs, but their welfare system is much more generous. A generous benefit scheme allows one space to adjust - further training, education, change career etc - than the more punitive systems of most of those to the left of NZ, including an active policy of shoehorning the unemployed into the next available job, at any wage rate.

    I just wonder which is the best in the long run as I prepare for 300 Macro later this year.

  3. Thanks for your thoughtful comments.

    Re intuition, yes, it's not obvious at first, esp as the regulations look on face value to be protective of employees, but if you put yourself in the employer's shoes, it becomes a lot clearer. Why, in Spain for example, which has unusually tough restrictions on firing, will an employer take the risk of hiring someone, when it will be virtually impossible to unravel later because of the protection provisions for permanent staff? At the least, hiring will likely be less than otherwise, and likely on short-term or casual arrangements, neither of which do much for employees (esp more marginal and younger ones). In France, there's a spike in 49-employee companies, which could well be 60 or 75 person employees but for the labour legislation. So it tends to be both counterproductive and (my special beef) inequitable: when hiring is scarce, who gets the jobs? The most talented, sure, but also the most connected and the 'insiders' (ask any French youngster). So you've got a policy that is both inefficient and inequitable.

    On the living wage, you might tend that way till you get to that precise point you mention: what about the people (again more on the outer than the inner) who clean the offices at night? Are they being 'protected' out of low productivity jobs? So I'm no labour expert, but I'd lean towards WFF/EITC myself as it seems to hit both targets of income support and employment for the more marginal.

    On your final point, I'm also all for support for training, education, career change etc and 'active labour market policies' in general: it seems to me to be a necessary part of the overall bundle, just as assistance for those displaced by free trade is a necessary part of the free trade bundle. Incidentally you might be interested in

    where in particular the IMF study cited might be worth following up. It shows that active labour market policies are apparently a more important thing to do than reform of employment protection legislation.