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IZA
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Labour-Market Institutions and Macroeconomic Shocks
by
Yu-Fu Chen, Dennis J. Snower, Gylfi Zoega
(July 2002)
published in: Labour, 2003, 17(2), 247-270
Abstract:
Macroeconomic shocks and labour-market institutions jointly determine employment growth
and economic performance. The effect of shocks depends on the nature of these institutions
and the effect of institutional change depends on the macroeconomic environment. It follows
that a given set of institutions may be appropriate at certain times in some countries while not
appropriate elsewhere. We derive a dynamic model of labour demand in which the effect of
firing costs on labour demand depends on the macroeconomic environment: When the level
of macroeconomic activity is expected to drop and/or the trend rate of productivity growth is
small, a rise in firing costs affects mainly (and adversely) the hiring decision and not the firing
decision. This makes firing costs harmful when they may appear to be most appropriate. The
intuition behind these results is quite straightforward: When managers fear that demand may
fall in the future they value the right to fire workers. It follows that by making this option more
costly, firing costs reduce the value of workers with adverse consequences for hiring and
firing.
Text: See Discussion Paper No. 539
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