- Email: [email protected]
On dismissal pay
Labour Economics 9 (2002) 497 – 512 www.elsevier.com/locate/econbase
On dismissal pay Laszlo Goerke * Department of Economics, University of Konstanz, D 138, D-78457 Constanze, Germany IZA, Bonn, Germany CESifo, Munich, Germany Received 1 June 2001; received in revised form 4 January 2002; accepted 21 February 2002
Abstract Wage and employment effects of payments in the case of individual and collective dismissals are investigated in a shirking model of efficiency wages. Payments for collective dismissals reduce the incentives to shirk and can increase employment and profits while they leave the workers’ payoff unaffected. Thus, they can be agreed upon at the firm level. An economy-wide introduction induces positive externalities, given the job creation effect. This contrasts with payments for individual dismissals, which decrease the combined payoff of firms, workers, and the government. D 2002 Elsevier Science B.V. All rights reserved. JEL classification: D 78; E 24; J 32; J 41; J 65 Keywords: Collective and individual dismissal; Dismissal pay; Efficiency wages
1. Introduction One of the most prominent examples of employment protection legislation (EPL) are firing costs. Theoretically, the labour demand effects of firing costs are ambiguous (Bentolila and Bertola, 1990; Bertola, 1999). On the one hand, firms dismiss less people for a given decline in the marginal value product of labour. On the other hand, firms hire fewer people owing to the increase in expected labour costs. However, the employment consequences of firing costs are not solely determined by the direct labour demand impact since wage formation can also be affected. Moreover, their impact can be influenced by the nature of the labour market. * Department of Economics, University of Konstanz, D 138, D-78457 Constanze, Germany. Tel.: +49-753188-2137; fax: +49-7531-88-3130. E-mail address: [email protected] (L. Goerke).
0927-5371/02/$ - see front matter D 2002 Elsevier Science B.V. All rights reserved. PII: S 0 9 2 7 - 5 3 7 1 ( 0 2 ) 0 0 0 4 4 - 1
498
L. Goerke / Labour Economics 9 (2002) 497–512
While Lazear (1990) has shown for a competitive setting that any increase in dismissal pay can be undone by a reduction in wages,1 Fella (2000) has demonstrated for a world characterised by unemployment due to efficiency wages that payments in the case of individual dismissals raise employment. This effect occurs because employees who provide too little effort and shirk do not obtain dismissal pay. However, Fella’s (2000) theoretical prediction is at variance with empirical evidence. Whereas positive employment effects of payments in the case of individual dismissals can generally not be found, a number of studies diagnose negative consequences (see OECD, 1999 or Addison and Teixeira, in press for surveys). Moreover, excluding shirkers from payments may be a contentious assumption. If that were possible, firms would have an incentive to claim that individual dismissals had been due to shirking. Accordingly, in many European countries, individual dismissals require gross misconduct by employees and not solely an insufficient work performance, for firms to escape obligations for dismissal payments (cf. Emerson, 1988; EIRR, 1999 or OECD, 1999). Thus, a good approximation of actual regulations may be that shirkers and nonshirkers alike are entitled to payments. While it might not be possible to distinguish whether a dismissal is due to shirking or a fall in the marginal value product of labour, mass redundancies can clearly be identified. Moreover, unless one presumes ‘collective shirking’, payments in the case of mass redundancies can differ from those to shirkers. This paper investigates the incentives for the introduction of dismissal pay, differentiating between transfers in the case of individual and collective redundancies and placing special emphasis on the ensuing wage adjustments in an efficiency wage economy. Since payments in the case of individual dismissals—due either to an exogenous shock or to having been caught providing insufficient effort—make shirking more attractive, the efficiency wage rises. Higher wages and dismissal costs reduce profits, but can raise the payoff of employed workers. Thus, such transfers can only be introduced if workers have substantial political power.2 In contrast, workers can benefit from payments in the case of mass redundancies only if they have not been dismissed individually. These payments mitigate the incentives to shirk, allow for lower wages and raise profits. Accordingly, there are incentives for an introduction of redundancy pay at the firm level. If employment rises, there will be a positive externality due to a higher reemployment probability and additional incentives to establish redundancy pay for the entire economy. Section 2 contains the shirking model of efficiency wages, based on the set-up by Shapiro and Stiglitz (1984). The model includes payments in the case of individual dismissals –labelled severance pay—and also for collective dismissals—referred to as redundancy pay. Section 3 analyses the changes in the payoffs due to an introduction of these payments. Section 4 concludes.
1
See also Booth (1997) or Burda (1992) who can derive the neutrality result for non-competitive models, as
well. 2
This paper does not explicitly model the political process but focuses on the question at what level—firm or entire economy—the introduction of dismissal pay is feasible. Political economy approaches to the determination of EPL are provided by Saint-Paul (1996, 2000, 2002), inter alia.
L. Goerke / Labour Economics 9 (2002) 497–512
499
2. Model Workers can lose their job for three distinct reasons. They might shirk and are caught doing so with probability q per unit of time. Moreover, a variation in the marginal value product of labour may occur. If the variation is negative and only of a minor nature, this will be interpreted as a ‘small’ shock such that the firm dismisses few workers who then obtain severance payments. The probability that a worker is dismissed owing to such a ‘small’ shock is b. There might also be a ‘large’ shock which requires the firm to fire a substantial fraction of its workforce and to make redundancy payments. The probability that a worker loses the job owing to such a mass redundancy is h. The probabilities b, h, and q are sufficiently small, implying that the time periods under consideration are very short and bq c bh c 0.3 Finally, there can be a positive shock to the marginal value product and the probability that a firm experiences such a shock is b. 2.1. Workers Workers are infinitely lived, discount future payments with the rate r, r > 0, cannot borrow or save and are characterised by an instantaneous utility w_ e, where w is the wage and e is the (disutility of) effort. Effort can either be high (e = e ) and conform _ to the level required by the company, or it can be low (e = 0). Unemployment benefits w are paid to every worker who loses the job.4 The discounted utility stream rVE,N from being employed and not shirking consists of the wage less the disutility from effort and the utility loss in the case of being fired. Denoting the utility in the case of being unemployed due to an individual dismissal by VU,D and due to a mass redundancy by VU,M, an employed nonshirker can be described by:5 rV E;N ¼ w e þ bðV U;D V E;N Þ þ hðV U;M V E;N Þ
ð1Þ
Simplification yields: V E;N ¼
w e þ bV U;D þ hV U;M rþbþh
ð2Þ
The expected life time utility of an employed shirker VE,S is: V E;S ¼
3
w þ ðb þ qÞV U;D þ hV U;M rþbþqþh
ð3Þ
Fixed dismissal probabilities imply that a change in the firm’s employment level does not alter the individual’s probability of losing a job. This contrasts with Fella’s (2000) hypothesis that a greater firm-specific employment level raises the probability of a job loss. One consequence of the differential assumptions is that hysteresis effects are feasible in Fella’s (2000) model (cf. Saint-Paul, 1995), which are of no relevance for the present analysis. 4 For an analysis of a situation in which shirkers are denied unemployment compensation see, for example, Bull (1985) or Goerke (2000). 5 Dismissal payments can either be incorporated into the utility stream from employment VE,N or from unemployment VU,D, respectively, VU,M. The choice obviously does not affect results.
500
L. Goerke / Labour Economics 9 (2002) 497–512
The discounted utility stream rVU,D _ of a worker who has been dismissed individually is defined by unemployment benefits w and severance payments r per period of unemployment, plus the expected utility gain owing to a new job. The presumption that workers cannot save requires the definition of dismissal pay as a transfer per unit of time. Moreover, Eqs. (2) and (3) are based on an assumption which reflects a predominant feature in Europe, namely that shirkers and nonshirkers who lose the job due to a small shock are both entitled to severance payments r.6 An unemployed worker finds a new job with probability a per period, the job acquisition rate. Since all workers provide the required amount of effort in equilibrium, re-employment yields a utility gain (VE,N VU,D). rV U;D ¼ w þ r þ aðV E;N V U;D Þ
ð4Þ
If the worker finds a new job, severance payments are terminated. This restriction justifies the assumption made implicitly above that discounted utility streams do not change over time. A worker who loses the job due to a mass dismissal is characterised by a utility stream VU,M and obtains redundancy pay S per period of unemployment. Since collective redundancies can clearly be distinguished from individual dismissals, redundancy and severance pay need not be the same, i.e. S p r may apply. This yields: V U;D ¼
w þ aV E;N r Sr ¼ V U;M þ rþa rþa rþa
ð5Þ
Using Eqs. (2) and (5), the expected lifetime utility VU,D of a worker who has lost the job owing to an individual dismissal is found to be: V U;D ¼
wðr þ b þ hÞ þ aðw eÞ þ ahðS=r þ aÞ þ ðr=r þ aÞ½rðr þ b þ h þ aÞ þ ba rðr þ b þ h þ aÞ
ð6Þ
A worker will not shirk if VE,N z VE,S holds. Substituting in accordance with Eqs. (5) and (6) and assuming the constraint to bind allows for the derivation of the efficiency wage we: e hS rðr þ h þ aÞ ¼0 we ðr þ b þ h þ aÞ e w þ q rþa rþa
ð7Þ
Redundancy pay makes only those workers better off who have not been caught shirking. Therefore, the incentives to provide the required level of effort rise and wages are reduced. However, payments to individually dismissed workers make shirking more attractive and raise the efficiency wage. 6 See Emerson (1988), EIRR (1999), or OECD (1999). In Germany, for example, dismissals can generally be disputed at labour courts. In a large majority of cases, no judgements are rendered but former employee and firm accept a settlement which usually entails severance pay, although there are no legal entitlements to such transfers (cf. Franz and Ru¨thers, 1999). The implications of excluding workers who have been dismissed for shirking from the receipt of severance pay are briefly discussed in the Conclusions.
L. Goerke / Labour Economics 9 (2002) 497–512
501
2.2. Firms There are a fixed number s of ex-ante identical firms. Consistency of the specification requires firms to choose a level of employment prior to the revelation of the shock, which will be too high if the shock is negative and too low if positive. Such a situation will arise, for example, if firms can vary employment at no costs before the type of shock is revealed, while they incur adjustment costs subsequent to its disclosure. Before the beginning of a period, each of the s firms sets an efficiency wage and chooses optimally the employment level n. Thus, the wage is not contingent on the economic situation (cf. Eq. (7)). A firm will employ Tn>n people if there is a positive shock, and Cn (Pn), 0 < P < C < 1, people if a small (large) adverse shock occurs, where T, C, and P are fixed. This will be true, for example, if each firm consists of a given number of departments, of which a fraction 1 C (1 P) closes down in the case of a small (large) shock. This assumption guarantees that dismissal pay has negative employment effects in the absence of wage adjustments, does not alter the relative impact of severance and redundancy pay, and allows to focus on the wage adjustment process. Shocks last one period and are not correlated over time. That is, the next period it is again optimal to employ n people. For simplicity and because the impact of dismissal pay is not affected by this presumption, the costless adjustment of employment prior to the beginning of a period takes place by reallocating workers from firms with excessive employment to those with an insufficient number of workers. Hence, the probabilities b, h, and a are unaffected by these adjustments. Given the above assumptions, expected profits are invariant over time. Let the probability that a firm experiences a positive shock and that, for example, the output _ _ price rises from unity to T , T >1, such that the firm employs Tn>n workers, be b, 0 < b < 1. Alternatively, b can be interpreted as the fraction of firms _ _ experiencing a positive shock. In the case of a small shock, the output price falls to C , C < 1 and employment is Cn. This state occurs with probability (1 b)c and entitles (1 C)n workers to severance pay r. The present value of the costs of such payments for firms equal r/(r + a) per worker, since workers find a new job with probability a, such _ _ that the ‘effective’ discount rate is given by r + a. A mass dismissal is due to a price P , P < 1, takes place with probability (1 b)p, leaves employment at Pn and assures (1 P)n workers of redundancy pay S.7 Dismissals can involve costs in addition to transfers, such as for legal proceedings or the adherence to procedural regulations (Bentolila and Bertola, 1990; Burda, 1992). These costs are represented by a mark-up n, n z 0, on dismissal payments. Firms pay taxes l, l z 0, which include all wage-related costs of employment but do not generate a direct benefit to employees. Since taxes on labour cost and income are equivalent in a Shapiro – Stiglitz efficiency wage economy (cf. Picard and Toulemonde, 2001 or Goerke, 2002), l also includes income taxes levied on workers. The production function f is strictly concave _ in effective employment ( f V(e n)>0, f W< 0), while the capital stock is fixed and its costs are
7 Since dismissal payments S and r are defined per period, whereas firms have to take into account their present value, some independent agency can be imagined which collects payments from firms at a point in time and hands out the transfers to dismissed workers over their infinite lifetime.
502
L. Goerke / Labour Economics 9 (2002) 497–512
normalised to zero. The gross efficiency wage is denoted by w˜e u we(1 + l), such that expected profits are: EðPÞ ¼ b½T f ðTneÞ w˜ e nT þ ð1 bÞð1 c pÞðf ðneÞ w˜ e nÞ þ ð1 bÞ cCf ðCneÞ þ pPf ðPneÞ ðcC þ pPÞw˜ e n nð1 þ nÞ ½cð1 CÞr þ pð1 PÞS rþa
ð8Þ
Denoting aggregate employment by N and normalising labour supply to unity, a steadystate in which flows into and out of unemployment are equal implies (b + h)N = a(1 N), since no worker shirks in equilibrium. The inflows into unemployment owing to dismissals are given by (1 b)snc(1 C) and have to equal the inflows on the aggregate scale, i.e. b=(1 b)c(1 C). Similarly, the inflows due to mass redundancies and outflows owing to higher firm-specific employment have to equal their aggregate counterparts. This implies N = sn and b(T 1) + 1 (1 b)[c(1 C) + p(1 P)] = 1. Substitution and maximisation of expected profits yields: dðEðPÞÞ hS þ br upn ¼ fˆ V we ð1 þ lÞ ð1 þ nÞ ¼ 0 dn rþa where fˆ VuefbT f VðTneÞT þ ð1 bÞ½ð1 c pÞf VðneÞ þ cCðf VðCneÞC þ pPðf VðPneÞPg > 0
ð9Þ
The second-order conditiozn pnn < 0 will be warranted if the production function is strictly concave as assumed above. 2.3. Employment effects Taking into account the wage adjustment, the variation in the firm-specific level of employment owing to dismissal payments can be derived as:
dn ¼ dr
dn ¼ dS
Bwe Br
b ð1 þ lÞ þ rþa ð1 þ nÞ ð1 þ lÞðr þ h þ aÞ þ ð1 þ nÞb ¼ <0 ðr þ aÞpnn pnn
ð10Þ
Bwe BS
h ð1 þ lÞ þ rþa ð1 þ nÞ hðn lÞ ¼ ðr þ aÞpnn pnn
ð11Þ
If not only one but all s firms introduce dismissal payments, the impact of changes in aggregate employment on the job acquisition rate a will have to be taken into account. However, the direction of the employment change is generally the same in aggregate as it
L. Goerke / Labour Economics 9 (2002) 497–512
503
is for a single firm (see Appendix A). Accordingly, severance payments r raise unemployment since wages increase and labour demand shrinks for a given level of wages. Redundancy payments S are only obtained by workers who have not been caught shirking. Hence, wages can fall. Employment will be unaffected if the tax rate and the firing cost mark-up are the same (l = n). This is because the fall in wages has to exactly compensate the rise in expected redundancy pay in order to induce risk-neutral workers to bring forward the same effort. If the fall in wages is amplified by taxes to the same extent as the increase in redundancy pay is boosted by the firing-cost mark-up, marginal employment costs and employment will remain constant. However, Garibaldi and Violante (1999) calculate that the nontransfer component of firing costs in Italy and the UK is less than 15%. Given nonwage labour costs in excess of 20% of wages (OECD, 1986) and income taxes which can easily surpass this percentage, a tax burden which exceeds the firing cost mark-up (l>n) is a plausible assumption. Given such a relationship, redundancy pay raises the number of jobs.8
3. Changes in payoffs This section analyses the incentives for introducing dismissal pay either at the firm level or for the entire economy. Dismissal pay will be favoured by an economic agent if his/her expected payoff rises. While variations in dismissal pay in a single firm have no impact on the reemployment probability a, this is the case for payments which apply to all employees. Initially, severance and, subsequently, redundancy payments are investigated. 3.1. Severance pay First, the impact of severance pay on profits is looked at. Second, alterations in the utility of workers are analysed. Since severance pay r not only drives up labour costs directly but also wages, expected profits E(P) decline for a given job acquisition rate a. dEðPÞ n ½ðr þ h þ aÞð1 þ lÞ þ bð1 þ nÞ < 0 ¼ dr j da ¼ 0 rþa
ð12Þ
To answer the question whether a worker and a firm can agree on the introduction of severance pay, that is, whether a worker can compensate the firm for the decline in expected profits, the change in the utility stream VE,N has to be analysed. According to Eq. (2), this analysis also requires the computation of the impact on the utility of dismissed
8 This result does not imply that redundancy pay can be increased without limits. All derivations are based on the restriction that VE,N>VU,M, which holds for a value of S such that S < e¯(r + a)/q + r (see also Saint-Paul (1995) or Fella (2000) for a similar restriction).
504
L. Goerke / Labour Economics 9 (2002) 497–512
workers. From Eqs. (5) and (6), it can be derived that severance payments r make dismissed workers better off: dV U;M dV U;D 1 a ¼ >0 ¼ dr j da ¼ 0 dr j da ¼ 0 r þ a rðr þ aÞ
ð13Þ
Using Eqs. (2), (5), and (13), the change in the utility stream of an employed worker is then found to be positive as, first, the wage and, second, the utility from becoming unemployed rise: dV E;N ¼ dr j da ¼ 0
Bwe Br
U;D
U;M
þ b dVdr jda¼0 þh dVdr jda¼0 1 >0 ¼ rþa rþbþh
ð14Þ
Assuming a common discount rate r and a given job acquisition rate a, the combination of the impact of severance pay on the firm and employees on a per-worker basis yields: 1 dEðPÞ dV E;N h þ b þ ðr þ h þ aÞl þ bn <0 ¼ þr n dr j da ¼ 0 rþa dr j da ¼ 0
ð15Þ
Proposition 1. A firm and a worker cannot agree on the introduction of severance payments for individual dismissals since their combined payoff will decline if shirkers are entitled to these payments. Proposition 1 implies that individual labour contracts will not contain agreements on severance pay in excess of the level which is mandated by law or collective agreements. This result is due to the following reasons: first, in the absence of wage adjustments, severance payments have negative employment consequences. Second, only the interests of employed workers affect the payoffs which influence the feasibility of an agreement. Third, the firing cost mark-up solely represents a loss to the firm but not a gain to workers. Fourth, higher wages raise total labour costs owing to the positive tax rate l. In contrast to a situation in which firms and workers agree on severance payments, they can also be the outcome of the political process, that is, be introduced in the entire economy. The feasibility of such an outcome is determined by the changes in the payoffs of firms, workers, and the government. Since the introduction of dismissal pay is analysed, the expected utility of a currently unemployed worker VU consists of _ unemployment _benefits w and the utility gain if becoming employed again and is given by VU=(w + aVE,N)/(r + a). The government’s payoff is represented by its tax receipts. Subsequently, it is analysed how the payoffs of the parties will change if they take into account general equilibrium repercussions. To do so, it is assumed that the inflow rate into unemployment (b + h) remains unaffected, while the outflow rate a adjusts in order to accommodate the variation in employment (see Appendix A). The actors are looked at in turn. Firms are exposed to random shocks and at the beginning of each period the same ex-ante level of employment is optimal. Thus, it was possible to relate the probability of firm-specific shocks to the dismissal probability. This implied that changes in the outflow rate were internalised at the firm level and profits unaffected by general equilibrium repercussions, for a given
L. Goerke / Labour Economics 9 (2002) 497–512
505
wage. However, from Eq. (7), it can be noted that the efficiency wage rises with the job acquisition rate, Bwe/Ba>0. Accordingly, expected profits E(P) will fall less with severance payments if general equilibrium repercussions are taken into account. Without further assumptions on the production function and the magnitude of effort or dismissal payments, the overall profit change cannot be ascertained. The impact of severance pay r on the utility stream VU,D of a worker who is dismissed individually can be derived by combining Eqs. (6) and (7) to substitute out the wage:
d
U;D
dV dr
¼
h i 1 e¯ w þ a þ r r q d
¼
1 e¯ þ ar r qr
ð16Þ
The direct effect of severance pay r on VU,D is positive. However, the reemployment probability a falls since employment per firm and in aggregate shrinks (ar < 0). This tends to reduce the expected utility VU,D because there is a direct negative impact of a lower job acquisition rate a and an indirect effect via the wage reduction. The overall consequences are uncertain. The change in an employed worker’s payoff can be derived using Eqs. (2), and (5) – (7): E;N
dV ¼ dr
d
h i 1 e¯ w þ ðr þ aÞ þ r r q d
¼
1 e¯ þ ar r qr
ð17Þ
Severance payments r have a positive impact on the utility stream of an employed worker for a given job acquisition rate. If, however, it is taken into account that severance pay raises unemployment and, thus, reduces the probability of finding a new job, the impact will become ambiguous, the second term in Eq. (17) being negative. Turning to an unemployed worker, the change in the payoff due to higher severance pay is also found to be ambiguous as the direct positive effect if becoming employed conflicts with the reduction in the reemployment probability: dV U V E;N r w a dV E;N ¼ ar þ 2 r þ a dr dr ðr þ aÞ
ð18Þ
Despite the ambiguities which the introduction of severance pay in the entire economy has upon the payoffs of workers, it can be shown that if employed workers favour such payments (dVE,N/dr>0), the incentives to introduce them will always be greater for employed than for unemployed.9 This is the case because, first, unemployed workers will
9
See also Saint-Paul (2000, 2002) for related findings.
506
L. Goerke / Labour Economics 9 (2002) 497–512
only benefit if they become employed, the probability of such an event being less than unity. Second, the probability declines that an unemployed worker finds a new job. From Eqs. (17) and (18), one obtains: dV E;N dV U dV E;N r ðb þ hÞðV E;N r wÞ Nr ¼ >0 dr dr dr r þ a ð1 N Þ2 ðr þ aÞ2 for dV E;N =dr > 0
ð19Þ
The previous computation has shown that if a group of workers benefits from the introduction of severance pay, the employed are most likely to do so. Moreover, the question arises if the entire economy can benefit from such payments. Its combined payoff H consists of profits of s firms, the utility stream of N employed and (1 N) unemployed workers and tax receipts, each discounted with the common rate r, H u NVE,N+(1 N)VU + sE(P)/r + lNwe/r. Combining the information from Eqs. (8) and (16) – (18), and the steadystate condition (b + h)N = a(1 N), the change in H due to severance payments r is found to be:
dH dV E;N dV U s dEðPÞ N l Bwe Bwe ¼N þ þ ð1 N Þ þ þ a dr r dr r dr dr Br Ba r i h þ N r V E;N V U þ we l=r
1 a V E;N r w e¯ e¯ ¼ N þ ar 1 þ ar þ ð1 N Þ þ ð1 N Þar r rðr þ aÞ qr q ðr þ aÞ2 i h hSn e¯ þ N r V E;N V U þ we l=r N ar ar qr ðr þ aÞ2
N h þ bð1 þ nÞ r þ h þ a þ bð1 þ nÞ rar ð20Þ rðr þ aÞ rþa Using Eqs. (7), (12), and (18), and (17), Eq. (20) can be simplified.
dH ð1 N Þar V E;N r w a¯e N rðh þ bð1 þ nÞÞ ¼ þ þ dr rðr þ aÞ rþa q ð1 N Þðr þ aÞ e Nbn w l E;N U þ Nr V V þ <0 rðr þ aÞ r
ð21Þ
The impact of severance payments on the society’s payoff H can be decomposed into three effects: the direct consequences due either to the loss of jobs or a reduction in profits and the indirect-equilibrium-consequences. The direct impact is captured by the second and the third term subsequent to the last equality sign in Eq. (21) and depicts the change in H for a given job acquisition rate. The second term describes the fall in profits due to higher expected red-tape costs of dismissals. The third term depicts the impact of a fall in employment. Every job loss reduces discounted tax receipts by wel/r and causes a utility
L. Goerke / Labour Economics 9 (2002) 497–512
507
change for a worker who becomes unemployed. As the utility stream of an employed worker VE,N must exceed the utility of an unemployed VU for anyone being willing to work, the overall effect is negative. Finally, the fall in the job acquisition rate (ar < 0) reduces the utility stream of employed and unemployed workers and also affects profits, as captured by the first term in square brackets in Eq._ (21). Since 1 N workers are without a job and will forego a utility increase of (VE,N w)/(r + a)2 if they remain so, the indirect effect of severance pay via the fall in the job acquisition rate is negative. The results can be summarised in Proposition 2: Proposition 2. The combined change in payoffs for firms, workers, and the government due to an economy-wide introduction of severance payments is negative. If employees favour the comprehensive introduction of severance pay, their gain will be greater than that of unemployed workers. 3.2. Redundancy pay The analysis of redundancy pay follows the same order as that of severance pay. First, the variations in payoffs due to an introduction of these payments at the firm level are looked at. Second, economy-wide redundancy payments are investigated. The changes in expected profits E(P), taking into account the wage variation, but holding constant the job acquisition rate a, are: dEðPÞ nh ½l n ¼ dS j da ¼ 0 r þ a
ð22Þ
While dismissal payments always decrease profits for a given level of wages, in the case of mass redundancies the wage falls and this reduction will be sufficient to raise profits if the tax l exceeds the firing cost mark-up f. Turning to workers, it can be noted that redundancy pay S will only alter the utility stream VU,D of a worker who loses the job owing to a small shock if s/he finds another job and loses the next one because of a large shock. However, the changes in wages and expected redundancy payments cancel out (cf. Eq. (6)), implying dVU,D/dS = 0 for da = 0. Workers who lose their job due to a collective dismissal benefit from redundancy pay (cf. Eqs. (5) – (7): dV U;M 1 >0 ¼ dS j da ¼ 0 r þ a
ð23Þ
Using Eqs. (2), (5), and (23), and dVU,D/dS = 0, the change in the utility stream of an employed worker due to redundancy payments, holding constant the outflow rate from unemployment, is found to be zero (dVE,N/dS = 0 for da = 0). Redundancy pay S leaves the
508
L. Goerke / Labour Economics 9 (2002) 497–512
utility of employed workers unaffected because the direct, negative wage effect exactly balances the increase in expected redundancy pay. Moreover, the utility if fired individually will be constant. Accordingly, employed workers are indifferent to the level of redundancy payments. This is because any change in expected redundancy payments is undone by a variation of the wage of the same magnitude but the opposite direction (cf. Eq. (6)). Such a wage adjustment ensures that the incentives to provide the required level of effort remain intact. Redundancy pay can increase the combined payoff of employed workers and the firm because the former are indifferent to such payments while a tax burden in excess of the firing cost mark-up in conjunction with a fall in wages implies that expected profits rise. Thus, redundancy payments for mass dismissals can be introduced at the firm level in a consensual manner, in contrast to severance payments for individual dismissals. The findings can be summed up in Proposition 3. Proposition 3. If employment rises with redundancy payments for collectively dismissed workers, an individual firm can negotiate a positive level with its workforce. If redundancy payments are introduced in the entire economy and raise employment per firm (l>n), the job acquisition rate will increase (aS>0). This entails higher wages and an uncertain impact on expected profits, that is, the sign of dE(P)/dS becomes indeterminate. The impact of a change in redundancy pay S on the utility stream VU,D of a worker who is dismissed individually can in analogy to the case of severance payments (cf. Eq. (16)) be derived as:
dV U;D d ¼ dS for l > n:
h 1 r
w þ qe¯ a þ r dS
i ¼
e¯ aS > 0 qr ð24Þ
An individually dismissed worker is better off due to redundancy pay for l>n, since it becomes more likely that s/he finds a new job. This raises the expected utility VU,D directly and also via the induced increase in wages (cf. Eq. (6)). The change in the utility stream VE,N of an employed worker can be derived from Eqs. (2), and (5) to (7) in the same way:
dV E;N e¯ ¼ aS > 0 qr dS
ð25Þ
The utility of an employed worker VE,N is unaffected by changes in redundancy pay S for a given job acquisition rate. A higher job acquisition rate (aS>0) reduces the utility loss from unemployment, since the efficiency wage increases and because VU,D rises with the
L. Goerke / Labour Economics 9 (2002) 497–512
509
reemployment probability a and the wage. Accordingly, redundancy payments will increase the utility stream of an employed worker for l>n if aggregate labour market effects are taken into account. As this positive externality can be internalised by introducing redundancy pay in all firms, the incentives to accept such payments become larger in contrast to a situation with a given job acquisition rate. Turning to an unemployed worker, the change in the utility stream VU due to redundancy pay will be positive if the tax rate exceeds _ the firing costs mark-up, implying aS>0, as the participation constraint requires VE,Nr>w. Moreover, a higher job acquisition rate also raises VU. dV U V E;N r w a dV E;N ¼ aS þ r þ a dS dS ðr þ aÞ2
ð26Þ
Eqs. (25) and (26) show that workers benefit from redundancy payments S irrespective of whether they currently have a job or not. However, the incentives for employed and unemployed workers to introduce redundancy pay S cannot be ranked. While the finding for severance payments—employed workers are more likely to support them than their unemployed counterparts—concurs with the results by Saint-Paul (2000, 2002), the potentially different impact for redundancy pay provides an additional argument for distinguishing between different forms of dismissal payments. Following the same methodology as for severance pay, the impact of introducing redundancy payments S on the combined payoff H of firms, workers, and the government can be calculated:
dH ð1 N ÞaS V E;N r w a¯e rh þ rbð1 þ nÞ þ hnS ¼ þ þN dS rþa q ð1 N Þðr þ aÞ rðr þ aÞ e Nhn wl þ NS V E;N V U þ rðr þ aÞ r
ð27Þ
Since the job acquisition rate and employment rise with redundancy pay S, all but the second term in Eq. (27) are positive. In contrast to severance pay, redundancy payments generate higher tax revenues and raise employment such that some formerly unemployed workers now obtain the utility stream from employment. This effect is captured by the third term in Eq. (27) in curly brackets. Moreover, the higher job acquisition rate raises the expected utility of current and future unemployed, as indicated by the expression in square brackets. Unless the increase in redundancy payments lowers profits strongly, because it implies higher dismissal expenditure due to the firing cost mark-up, the society’s payoff rises. This positive effect will be strengthened if the reduction in expenditure for unemployment compensation is taken into account. This yields Proposition 4.
510
L. Goerke / Labour Economics 9 (2002) 497–512
Table 1 Changes in payoffs—summary of comparative static effects for l>n Severance pay, r F Firm-level increase
Economy-wide increase
Redundancy pay, S
E
U
G
F
E
U
G
þ |fflfflfflfflfflfflfflfflffl{zfflfflfflfflfflfflfflfflffl}
+
?
þ |fflfflfflfflfflfflfflfflfflffl{zfflfflfflfflfflfflfflfflfflffl0}
0
?
? ?
? ffl{zfflfflfflfflfflfflfflfflffl?} |fflfflfflfflfflfflfflffl
+ ?
+ ?|fflfflfflfflfflfflfflfflfflffl{zfflfflfflfflfflfflfflfflfflþ ffl}
+a
F—firm; E—employed; U—unemployed; G—government. a Unambiguously positive effect requires sufficiently low firing cost mark-up.
Proposition 4. If employment rises with redundancy pay for collective dismissals, its economy-wide introduction will have ambiguous profit effects, while workers benefit. In the absence of additional firing costs (n = 0), the combined change in payoffs for firms, workers, and government is positive. 3.3. Comparison Propositions 1 –4 indicate that the changes in payoffs due to dismissal pay may depend crucially on whether detected shirkers can be excluded from these payments, as it has been argued to be the case for redundancy pay for collective dismissals but not for severance payments for individual dismissals. Moreover, the incentives for introducing dismissal pay at the firm level or for the entire the economy can differ. The variation in payoffs are summarised in Table 1.
4. Conclusions The theoretical predictions summarised in Table 1 are broadly supported by OECD (1999) evidence. With the exception of countries from southern Europe and Oceania, severance payments are generally close to zero unless workers have been employed in the same company for 20 years. Entitlements to redundancy payments seem to be more widespread. The analysis of this paper can be interpreted as a rationalisation of these features. Moreover, the predictions may provide insights into the empirical findings of differential unemployment effects of payments for individual and collective dismissals (Feld, 2001). However, severance payments for individual dismissals can be observed in many countries for workers with high tenure. In terms of the above model, this finding could be rationalised if the possibility of excluding shirkers from the receipt of severance payments for individual dismissals rises with tenure because work performance can be documented more precisely. If shirkers can generally be excluded from the receipt of severance payments to some extent, the negative employment consequences of severance payments will be weakened further. Finally, allowing for positive employment effects of
L. Goerke / Labour Economics 9 (2002) 497–512
511
severance pay in the absence of wage adjustments, by endogenising the extent of employment adjustments in the case of shocks, can enhance the incentives for their introduction.
Acknowledgements I am grateful for comments by Carsten Hefeker, Bernhard Boockmann, Guilio Piccirilli, and two anonymous referees as well as by participants of the annual meetings of the European Public Choice Society in Paris, the European Association of Labour Economists in Jyva¨skyla, and the 10th Silvaplana Workshop on Political Economy.
Appendix A Aggregate employment is determined using the steady-state condition h + b=(1 N)a/ N. Differentiation yields the expression in the main text. Substituting in Eq. (7), one obtains: bþh hSð1 N Þ e¯ Zuwe rþ e¯ w þ 1N rð1 N Þ þ ðh þ bÞN q hð1 N Þ r 1þ ¼0 ðIÞ rð1 N Þ þ ðh þ bÞN Aggregating over all s firms one obtains from Eq. (9): Y ¼ fˆ VðN Þ we ð1 þ lÞ
ðhS þ brÞð1 N Þð1 þ nÞ ¼0 rð1 N Þ þ ðh þ bÞN
ðIIÞ
The derivatives of Z and Y are given by Zw = 1, Yw = 1 l < 0, ZS = h/(r + a)>0, YS = (1 + n)h/(r + a) < 0, Yr = (1 + n)b/(r + a) < 0, " # bþh hðr SÞ e¯ ðr þ a þ hÞ < 0; and ZN ¼ < 0 ; Zr ¼ 2 2 rþa q ð1 N Þ ðr þ aÞ ðh þ bÞðhS þ brÞð1 þ nÞ YN ¼ fˆ W¯e þ : ðr þ aÞ2 ð1 N Þ2
ðIIIÞ
The determinant of the system will unambiguously be negative if j = 0 and A z s or j = S = 0, that is in any case if dismissal are introduced. The changes in aggregate employment N due to higher dismmissal pay for YNZw ZNYw < 0 are: dN hðn lÞ=ðr þ aÞ ¼ > 0 for l > n dS YN Zw ZN Yw
ðIVÞ
512
L. Goerke / Labour Economics 9 (2002) 497–512
dN bð1 þ nÞ þ ð1 þ lÞ½r þ a þ h ¼ <0 dr ðr þ aÞðYN Zw ZN Yw Þ
ðVÞ
References Addison, J.T., Teixeira, P., The economics of employment protection. Journal of Labor Research, in press. Bentolila, S., Bertola, G., 1990. Firing costs and labor demand: how bad is eurosclerosis? Review of Economic Studies 57, 381 – 402. Bertola, G., 1999. Microeconomic perspectives on aggregate labor markets. In: Ashenfelter, O., Card, D. (Eds.), Handbook of Labor Economics, vol. 3c. North-Holland, Amsterdam, pp. 2985 – 3028. Booth, A.L., 1997. An analysis of firing costs and their implications for unemployment policy. In: Snower, D.J., de la Dehesa, G. (Eds.), Unemployment Policy: Government Options for the Labour Market, Cambridge Univ. Press, Cambridge, pp. 359 – 388. Bull, C., 1985. Equilibrium unemployment as a worker discipline device: comment. American Economic Review 75, 890 – 891. Burda, M.C., 1992. A note on firing costs and severance benefits in equilibrium unemployment. Scandinavian Journal of Economics 94, 479 – 489. European Industrial Relations Review (EIRR), 1999. Individual Dismissals in Europe, Parts 1 – 3, 306: 30 – 36, 308: 20 – 23, 311: 31 – 35. Emerson, M., 1988. Regulation or deregulation of the labour market: policy regimes for the recruitment and dismissal of employees in industrialised countries. European Economic Review 32, 775 – 817. Feld, L., 2001. Growth, Unemployment, Investment, and Employment Protection Legislation: Panel Evidence for the EU-12 from 1970 to 1996. Mimeo, University of St. Gallen. Fella, G., 2000. Efficiency wages and efficient redundancy pay. European Economic Review 44, 1473 – 1490. ¨ konomie (Labour law and economics). Recht der Arbeit, 32 – 38. Franz, W., Ru¨thers, B., 1999. Arbeitsrecht und O Garibaldi, P., Violante, G.L., 1999. Severance Payments in Search Economies with Limited Bonding. Mimeo, University College London. Goerke, L., 2000. On the structure of unemployment benefits in shirking models. Labour Economics 7, 283 – 295. Goerke, L., 2002. Taxes and Unemployment. Kluwer Academic Publishers, Boston. Lazear, E.P., 1990. Job security provisions and employment. Quarterly Journal of Economics 105, 699 – 726. OECD, 1986. Non-wage labour costs and employment. Employment Outlook, OECD, Paris, 80 – 85. OECD, 1999. Employment protection and labour market performance. Employment Outlook. OECD, Paris, 47 – 132. Picard, P.M., Toulemonde, E., 2001. On the equivalence of taxes paid by employers and employees. Scottish Journal of Political Economy 48, 461 – 470. Saint-Paul, G., 1995. Efficiency wage, commitment and hysteresis. Annales d’Economie et de Statistique 37/38, 39 – 53. Saint-Paul, G., 1996. Exploring the political economy of labour market institutions. Economic Policy 11, 265 – 315. Saint-Paul, G., 2000. The political economy of labour market institutions. Oxford Univ. Press, Oxford. Saint-Paul, G., 2002. The political economy of employment protection. Journal of Political Economy 110, 672 – 704. Shapiro, C., Stiglitz, J.E., 1984. Equilibrium unemployment as a worker discipline device. American Economic Review 74, 433 – 444.
On dismissal pay Laszlo Goerke * Department of Economics, University of Konstanz, D 138, D-78457 Constanze, Germany IZA, Bonn, Germany CESifo, Munich, Germany Received 1 June 2001; received in revised form 4 January 2002; accepted 21 February 2002
Abstract Wage and employment effects of payments in the case of individual and collective dismissals are investigated in a shirking model of efficiency wages. Payments for collective dismissals reduce the incentives to shirk and can increase employment and profits while they leave the workers’ payoff unaffected. Thus, they can be agreed upon at the firm level. An economy-wide introduction induces positive externalities, given the job creation effect. This contrasts with payments for individual dismissals, which decrease the combined payoff of firms, workers, and the government. D 2002 Elsevier Science B.V. All rights reserved. JEL classification: D 78; E 24; J 32; J 41; J 65 Keywords: Collective and individual dismissal; Dismissal pay; Efficiency wages
1. Introduction One of the most prominent examples of employment protection legislation (EPL) are firing costs. Theoretically, the labour demand effects of firing costs are ambiguous (Bentolila and Bertola, 1990; Bertola, 1999). On the one hand, firms dismiss less people for a given decline in the marginal value product of labour. On the other hand, firms hire fewer people owing to the increase in expected labour costs. However, the employment consequences of firing costs are not solely determined by the direct labour demand impact since wage formation can also be affected. Moreover, their impact can be influenced by the nature of the labour market. * Department of Economics, University of Konstanz, D 138, D-78457 Constanze, Germany. Tel.: +49-753188-2137; fax: +49-7531-88-3130. E-mail address: [email protected] (L. Goerke).
0927-5371/02/$ - see front matter D 2002 Elsevier Science B.V. All rights reserved. PII: S 0 9 2 7 - 5 3 7 1 ( 0 2 ) 0 0 0 4 4 - 1
498
L. Goerke / Labour Economics 9 (2002) 497–512
While Lazear (1990) has shown for a competitive setting that any increase in dismissal pay can be undone by a reduction in wages,1 Fella (2000) has demonstrated for a world characterised by unemployment due to efficiency wages that payments in the case of individual dismissals raise employment. This effect occurs because employees who provide too little effort and shirk do not obtain dismissal pay. However, Fella’s (2000) theoretical prediction is at variance with empirical evidence. Whereas positive employment effects of payments in the case of individual dismissals can generally not be found, a number of studies diagnose negative consequences (see OECD, 1999 or Addison and Teixeira, in press for surveys). Moreover, excluding shirkers from payments may be a contentious assumption. If that were possible, firms would have an incentive to claim that individual dismissals had been due to shirking. Accordingly, in many European countries, individual dismissals require gross misconduct by employees and not solely an insufficient work performance, for firms to escape obligations for dismissal payments (cf. Emerson, 1988; EIRR, 1999 or OECD, 1999). Thus, a good approximation of actual regulations may be that shirkers and nonshirkers alike are entitled to payments. While it might not be possible to distinguish whether a dismissal is due to shirking or a fall in the marginal value product of labour, mass redundancies can clearly be identified. Moreover, unless one presumes ‘collective shirking’, payments in the case of mass redundancies can differ from those to shirkers. This paper investigates the incentives for the introduction of dismissal pay, differentiating between transfers in the case of individual and collective redundancies and placing special emphasis on the ensuing wage adjustments in an efficiency wage economy. Since payments in the case of individual dismissals—due either to an exogenous shock or to having been caught providing insufficient effort—make shirking more attractive, the efficiency wage rises. Higher wages and dismissal costs reduce profits, but can raise the payoff of employed workers. Thus, such transfers can only be introduced if workers have substantial political power.2 In contrast, workers can benefit from payments in the case of mass redundancies only if they have not been dismissed individually. These payments mitigate the incentives to shirk, allow for lower wages and raise profits. Accordingly, there are incentives for an introduction of redundancy pay at the firm level. If employment rises, there will be a positive externality due to a higher reemployment probability and additional incentives to establish redundancy pay for the entire economy. Section 2 contains the shirking model of efficiency wages, based on the set-up by Shapiro and Stiglitz (1984). The model includes payments in the case of individual dismissals –labelled severance pay—and also for collective dismissals—referred to as redundancy pay. Section 3 analyses the changes in the payoffs due to an introduction of these payments. Section 4 concludes.
1
See also Booth (1997) or Burda (1992) who can derive the neutrality result for non-competitive models, as
well. 2
This paper does not explicitly model the political process but focuses on the question at what level—firm or entire economy—the introduction of dismissal pay is feasible. Political economy approaches to the determination of EPL are provided by Saint-Paul (1996, 2000, 2002), inter alia.
L. Goerke / Labour Economics 9 (2002) 497–512
499
2. Model Workers can lose their job for three distinct reasons. They might shirk and are caught doing so with probability q per unit of time. Moreover, a variation in the marginal value product of labour may occur. If the variation is negative and only of a minor nature, this will be interpreted as a ‘small’ shock such that the firm dismisses few workers who then obtain severance payments. The probability that a worker is dismissed owing to such a ‘small’ shock is b. There might also be a ‘large’ shock which requires the firm to fire a substantial fraction of its workforce and to make redundancy payments. The probability that a worker loses the job owing to such a mass redundancy is h. The probabilities b, h, and q are sufficiently small, implying that the time periods under consideration are very short and bq c bh c 0.3 Finally, there can be a positive shock to the marginal value product and the probability that a firm experiences such a shock is b. 2.1. Workers Workers are infinitely lived, discount future payments with the rate r, r > 0, cannot borrow or save and are characterised by an instantaneous utility w_ e, where w is the wage and e is the (disutility of) effort. Effort can either be high (e = e ) and conform _ to the level required by the company, or it can be low (e = 0). Unemployment benefits w are paid to every worker who loses the job.4 The discounted utility stream rVE,N from being employed and not shirking consists of the wage less the disutility from effort and the utility loss in the case of being fired. Denoting the utility in the case of being unemployed due to an individual dismissal by VU,D and due to a mass redundancy by VU,M, an employed nonshirker can be described by:5 rV E;N ¼ w e þ bðV U;D V E;N Þ þ hðV U;M V E;N Þ
ð1Þ
Simplification yields: V E;N ¼
w e þ bV U;D þ hV U;M rþbþh
ð2Þ
The expected life time utility of an employed shirker VE,S is: V E;S ¼
3
w þ ðb þ qÞV U;D þ hV U;M rþbþqþh
ð3Þ
Fixed dismissal probabilities imply that a change in the firm’s employment level does not alter the individual’s probability of losing a job. This contrasts with Fella’s (2000) hypothesis that a greater firm-specific employment level raises the probability of a job loss. One consequence of the differential assumptions is that hysteresis effects are feasible in Fella’s (2000) model (cf. Saint-Paul, 1995), which are of no relevance for the present analysis. 4 For an analysis of a situation in which shirkers are denied unemployment compensation see, for example, Bull (1985) or Goerke (2000). 5 Dismissal payments can either be incorporated into the utility stream from employment VE,N or from unemployment VU,D, respectively, VU,M. The choice obviously does not affect results.
500
L. Goerke / Labour Economics 9 (2002) 497–512
The discounted utility stream rVU,D _ of a worker who has been dismissed individually is defined by unemployment benefits w and severance payments r per period of unemployment, plus the expected utility gain owing to a new job. The presumption that workers cannot save requires the definition of dismissal pay as a transfer per unit of time. Moreover, Eqs. (2) and (3) are based on an assumption which reflects a predominant feature in Europe, namely that shirkers and nonshirkers who lose the job due to a small shock are both entitled to severance payments r.6 An unemployed worker finds a new job with probability a per period, the job acquisition rate. Since all workers provide the required amount of effort in equilibrium, re-employment yields a utility gain (VE,N VU,D). rV U;D ¼ w þ r þ aðV E;N V U;D Þ
ð4Þ
If the worker finds a new job, severance payments are terminated. This restriction justifies the assumption made implicitly above that discounted utility streams do not change over time. A worker who loses the job due to a mass dismissal is characterised by a utility stream VU,M and obtains redundancy pay S per period of unemployment. Since collective redundancies can clearly be distinguished from individual dismissals, redundancy and severance pay need not be the same, i.e. S p r may apply. This yields: V U;D ¼
w þ aV E;N r Sr ¼ V U;M þ rþa rþa rþa
ð5Þ
Using Eqs. (2) and (5), the expected lifetime utility VU,D of a worker who has lost the job owing to an individual dismissal is found to be: V U;D ¼
wðr þ b þ hÞ þ aðw eÞ þ ahðS=r þ aÞ þ ðr=r þ aÞ½rðr þ b þ h þ aÞ þ ba rðr þ b þ h þ aÞ
ð6Þ
A worker will not shirk if VE,N z VE,S holds. Substituting in accordance with Eqs. (5) and (6) and assuming the constraint to bind allows for the derivation of the efficiency wage we: e hS rðr þ h þ aÞ ¼0 we ðr þ b þ h þ aÞ e w þ q rþa rþa
ð7Þ
Redundancy pay makes only those workers better off who have not been caught shirking. Therefore, the incentives to provide the required level of effort rise and wages are reduced. However, payments to individually dismissed workers make shirking more attractive and raise the efficiency wage. 6 See Emerson (1988), EIRR (1999), or OECD (1999). In Germany, for example, dismissals can generally be disputed at labour courts. In a large majority of cases, no judgements are rendered but former employee and firm accept a settlement which usually entails severance pay, although there are no legal entitlements to such transfers (cf. Franz and Ru¨thers, 1999). The implications of excluding workers who have been dismissed for shirking from the receipt of severance pay are briefly discussed in the Conclusions.
L. Goerke / Labour Economics 9 (2002) 497–512
501
2.2. Firms There are a fixed number s of ex-ante identical firms. Consistency of the specification requires firms to choose a level of employment prior to the revelation of the shock, which will be too high if the shock is negative and too low if positive. Such a situation will arise, for example, if firms can vary employment at no costs before the type of shock is revealed, while they incur adjustment costs subsequent to its disclosure. Before the beginning of a period, each of the s firms sets an efficiency wage and chooses optimally the employment level n. Thus, the wage is not contingent on the economic situation (cf. Eq. (7)). A firm will employ Tn>n people if there is a positive shock, and Cn (Pn), 0 < P < C < 1, people if a small (large) adverse shock occurs, where T, C, and P are fixed. This will be true, for example, if each firm consists of a given number of departments, of which a fraction 1 C (1 P) closes down in the case of a small (large) shock. This assumption guarantees that dismissal pay has negative employment effects in the absence of wage adjustments, does not alter the relative impact of severance and redundancy pay, and allows to focus on the wage adjustment process. Shocks last one period and are not correlated over time. That is, the next period it is again optimal to employ n people. For simplicity and because the impact of dismissal pay is not affected by this presumption, the costless adjustment of employment prior to the beginning of a period takes place by reallocating workers from firms with excessive employment to those with an insufficient number of workers. Hence, the probabilities b, h, and a are unaffected by these adjustments. Given the above assumptions, expected profits are invariant over time. Let the probability that a firm experiences a positive shock and that, for example, the output _ _ price rises from unity to T , T >1, such that the firm employs Tn>n workers, be b, 0 < b < 1. Alternatively, b can be interpreted as the fraction of firms _ _ experiencing a positive shock. In the case of a small shock, the output price falls to C , C < 1 and employment is Cn. This state occurs with probability (1 b)c and entitles (1 C)n workers to severance pay r. The present value of the costs of such payments for firms equal r/(r + a) per worker, since workers find a new job with probability a, such _ _ that the ‘effective’ discount rate is given by r + a. A mass dismissal is due to a price P , P < 1, takes place with probability (1 b)p, leaves employment at Pn and assures (1 P)n workers of redundancy pay S.7 Dismissals can involve costs in addition to transfers, such as for legal proceedings or the adherence to procedural regulations (Bentolila and Bertola, 1990; Burda, 1992). These costs are represented by a mark-up n, n z 0, on dismissal payments. Firms pay taxes l, l z 0, which include all wage-related costs of employment but do not generate a direct benefit to employees. Since taxes on labour cost and income are equivalent in a Shapiro – Stiglitz efficiency wage economy (cf. Picard and Toulemonde, 2001 or Goerke, 2002), l also includes income taxes levied on workers. The production function f is strictly concave _ in effective employment ( f V(e n)>0, f W< 0), while the capital stock is fixed and its costs are
7 Since dismissal payments S and r are defined per period, whereas firms have to take into account their present value, some independent agency can be imagined which collects payments from firms at a point in time and hands out the transfers to dismissed workers over their infinite lifetime.
502
L. Goerke / Labour Economics 9 (2002) 497–512
normalised to zero. The gross efficiency wage is denoted by w˜e u we(1 + l), such that expected profits are: EðPÞ ¼ b½T f ðTneÞ w˜ e nT þ ð1 bÞð1 c pÞðf ðneÞ w˜ e nÞ þ ð1 bÞ cCf ðCneÞ þ pPf ðPneÞ ðcC þ pPÞw˜ e n nð1 þ nÞ ½cð1 CÞr þ pð1 PÞS rþa
ð8Þ
Denoting aggregate employment by N and normalising labour supply to unity, a steadystate in which flows into and out of unemployment are equal implies (b + h)N = a(1 N), since no worker shirks in equilibrium. The inflows into unemployment owing to dismissals are given by (1 b)snc(1 C) and have to equal the inflows on the aggregate scale, i.e. b=(1 b)c(1 C). Similarly, the inflows due to mass redundancies and outflows owing to higher firm-specific employment have to equal their aggregate counterparts. This implies N = sn and b(T 1) + 1 (1 b)[c(1 C) + p(1 P)] = 1. Substitution and maximisation of expected profits yields: dðEðPÞÞ hS þ br upn ¼ fˆ V we ð1 þ lÞ ð1 þ nÞ ¼ 0 dn rþa where fˆ VuefbT f VðTneÞT þ ð1 bÞ½ð1 c pÞf VðneÞ þ cCðf VðCneÞC þ pPðf VðPneÞPg > 0
ð9Þ
The second-order conditiozn pnn < 0 will be warranted if the production function is strictly concave as assumed above. 2.3. Employment effects Taking into account the wage adjustment, the variation in the firm-specific level of employment owing to dismissal payments can be derived as:
dn ¼ dr
dn ¼ dS
Bwe Br
b ð1 þ lÞ þ rþa ð1 þ nÞ ð1 þ lÞðr þ h þ aÞ þ ð1 þ nÞb ¼ <0 ðr þ aÞpnn pnn
ð10Þ
Bwe BS
h ð1 þ lÞ þ rþa ð1 þ nÞ hðn lÞ ¼ ðr þ aÞpnn pnn
ð11Þ
If not only one but all s firms introduce dismissal payments, the impact of changes in aggregate employment on the job acquisition rate a will have to be taken into account. However, the direction of the employment change is generally the same in aggregate as it
L. Goerke / Labour Economics 9 (2002) 497–512
503
is for a single firm (see Appendix A). Accordingly, severance payments r raise unemployment since wages increase and labour demand shrinks for a given level of wages. Redundancy payments S are only obtained by workers who have not been caught shirking. Hence, wages can fall. Employment will be unaffected if the tax rate and the firing cost mark-up are the same (l = n). This is because the fall in wages has to exactly compensate the rise in expected redundancy pay in order to induce risk-neutral workers to bring forward the same effort. If the fall in wages is amplified by taxes to the same extent as the increase in redundancy pay is boosted by the firing-cost mark-up, marginal employment costs and employment will remain constant. However, Garibaldi and Violante (1999) calculate that the nontransfer component of firing costs in Italy and the UK is less than 15%. Given nonwage labour costs in excess of 20% of wages (OECD, 1986) and income taxes which can easily surpass this percentage, a tax burden which exceeds the firing cost mark-up (l>n) is a plausible assumption. Given such a relationship, redundancy pay raises the number of jobs.8
3. Changes in payoffs This section analyses the incentives for introducing dismissal pay either at the firm level or for the entire economy. Dismissal pay will be favoured by an economic agent if his/her expected payoff rises. While variations in dismissal pay in a single firm have no impact on the reemployment probability a, this is the case for payments which apply to all employees. Initially, severance and, subsequently, redundancy payments are investigated. 3.1. Severance pay First, the impact of severance pay on profits is looked at. Second, alterations in the utility of workers are analysed. Since severance pay r not only drives up labour costs directly but also wages, expected profits E(P) decline for a given job acquisition rate a. dEðPÞ n ½ðr þ h þ aÞð1 þ lÞ þ bð1 þ nÞ < 0 ¼ dr j da ¼ 0 rþa
ð12Þ
To answer the question whether a worker and a firm can agree on the introduction of severance pay, that is, whether a worker can compensate the firm for the decline in expected profits, the change in the utility stream VE,N has to be analysed. According to Eq. (2), this analysis also requires the computation of the impact on the utility of dismissed
8 This result does not imply that redundancy pay can be increased without limits. All derivations are based on the restriction that VE,N>VU,M, which holds for a value of S such that S < e¯(r + a)/q + r (see also Saint-Paul (1995) or Fella (2000) for a similar restriction).
504
L. Goerke / Labour Economics 9 (2002) 497–512
workers. From Eqs. (5) and (6), it can be derived that severance payments r make dismissed workers better off: dV U;M dV U;D 1 a ¼ >0 ¼ dr j da ¼ 0 dr j da ¼ 0 r þ a rðr þ aÞ
ð13Þ
Using Eqs. (2), (5), and (13), the change in the utility stream of an employed worker is then found to be positive as, first, the wage and, second, the utility from becoming unemployed rise: dV E;N ¼ dr j da ¼ 0
Bwe Br
U;D
U;M
þ b dVdr jda¼0 þh dVdr jda¼0 1 >0 ¼ rþa rþbþh
ð14Þ
Assuming a common discount rate r and a given job acquisition rate a, the combination of the impact of severance pay on the firm and employees on a per-worker basis yields: 1 dEðPÞ dV E;N h þ b þ ðr þ h þ aÞl þ bn <0 ¼ þr n dr j da ¼ 0 rþa dr j da ¼ 0
ð15Þ
Proposition 1. A firm and a worker cannot agree on the introduction of severance payments for individual dismissals since their combined payoff will decline if shirkers are entitled to these payments. Proposition 1 implies that individual labour contracts will not contain agreements on severance pay in excess of the level which is mandated by law or collective agreements. This result is due to the following reasons: first, in the absence of wage adjustments, severance payments have negative employment consequences. Second, only the interests of employed workers affect the payoffs which influence the feasibility of an agreement. Third, the firing cost mark-up solely represents a loss to the firm but not a gain to workers. Fourth, higher wages raise total labour costs owing to the positive tax rate l. In contrast to a situation in which firms and workers agree on severance payments, they can also be the outcome of the political process, that is, be introduced in the entire economy. The feasibility of such an outcome is determined by the changes in the payoffs of firms, workers, and the government. Since the introduction of dismissal pay is analysed, the expected utility of a currently unemployed worker VU consists of _ unemployment _benefits w and the utility gain if becoming employed again and is given by VU=(w + aVE,N)/(r + a). The government’s payoff is represented by its tax receipts. Subsequently, it is analysed how the payoffs of the parties will change if they take into account general equilibrium repercussions. To do so, it is assumed that the inflow rate into unemployment (b + h) remains unaffected, while the outflow rate a adjusts in order to accommodate the variation in employment (see Appendix A). The actors are looked at in turn. Firms are exposed to random shocks and at the beginning of each period the same ex-ante level of employment is optimal. Thus, it was possible to relate the probability of firm-specific shocks to the dismissal probability. This implied that changes in the outflow rate were internalised at the firm level and profits unaffected by general equilibrium repercussions, for a given
L. Goerke / Labour Economics 9 (2002) 497–512
505
wage. However, from Eq. (7), it can be noted that the efficiency wage rises with the job acquisition rate, Bwe/Ba>0. Accordingly, expected profits E(P) will fall less with severance payments if general equilibrium repercussions are taken into account. Without further assumptions on the production function and the magnitude of effort or dismissal payments, the overall profit change cannot be ascertained. The impact of severance pay r on the utility stream VU,D of a worker who is dismissed individually can be derived by combining Eqs. (6) and (7) to substitute out the wage:
d
U;D
dV dr
¼
h i 1 e¯ w þ a þ r r q d
¼
1 e¯ þ ar r qr
ð16Þ
The direct effect of severance pay r on VU,D is positive. However, the reemployment probability a falls since employment per firm and in aggregate shrinks (ar < 0). This tends to reduce the expected utility VU,D because there is a direct negative impact of a lower job acquisition rate a and an indirect effect via the wage reduction. The overall consequences are uncertain. The change in an employed worker’s payoff can be derived using Eqs. (2), and (5) – (7): E;N
dV ¼ dr
d
h i 1 e¯ w þ ðr þ aÞ þ r r q d
¼
1 e¯ þ ar r qr
ð17Þ
Severance payments r have a positive impact on the utility stream of an employed worker for a given job acquisition rate. If, however, it is taken into account that severance pay raises unemployment and, thus, reduces the probability of finding a new job, the impact will become ambiguous, the second term in Eq. (17) being negative. Turning to an unemployed worker, the change in the payoff due to higher severance pay is also found to be ambiguous as the direct positive effect if becoming employed conflicts with the reduction in the reemployment probability: dV U V E;N r w a dV E;N ¼ ar þ 2 r þ a dr dr ðr þ aÞ
ð18Þ
Despite the ambiguities which the introduction of severance pay in the entire economy has upon the payoffs of workers, it can be shown that if employed workers favour such payments (dVE,N/dr>0), the incentives to introduce them will always be greater for employed than for unemployed.9 This is the case because, first, unemployed workers will
9
See also Saint-Paul (2000, 2002) for related findings.
506
L. Goerke / Labour Economics 9 (2002) 497–512
only benefit if they become employed, the probability of such an event being less than unity. Second, the probability declines that an unemployed worker finds a new job. From Eqs. (17) and (18), one obtains: dV E;N dV U dV E;N r ðb þ hÞðV E;N r wÞ Nr ¼ >0 dr dr dr r þ a ð1 N Þ2 ðr þ aÞ2 for dV E;N =dr > 0
ð19Þ
The previous computation has shown that if a group of workers benefits from the introduction of severance pay, the employed are most likely to do so. Moreover, the question arises if the entire economy can benefit from such payments. Its combined payoff H consists of profits of s firms, the utility stream of N employed and (1 N) unemployed workers and tax receipts, each discounted with the common rate r, H u NVE,N+(1 N)VU + sE(P)/r + lNwe/r. Combining the information from Eqs. (8) and (16) – (18), and the steadystate condition (b + h)N = a(1 N), the change in H due to severance payments r is found to be:
dH dV E;N dV U s dEðPÞ N l Bwe Bwe ¼N þ þ ð1 N Þ þ þ a dr r dr r dr dr Br Ba r i h þ N r V E;N V U þ we l=r
1 a V E;N r w e¯ e¯ ¼ N þ ar 1 þ ar þ ð1 N Þ þ ð1 N Þar r rðr þ aÞ qr q ðr þ aÞ2 i h hSn e¯ þ N r V E;N V U þ we l=r N ar ar qr ðr þ aÞ2
N h þ bð1 þ nÞ r þ h þ a þ bð1 þ nÞ rar ð20Þ rðr þ aÞ rþa Using Eqs. (7), (12), and (18), and (17), Eq. (20) can be simplified.
dH ð1 N Þar V E;N r w a¯e N rðh þ bð1 þ nÞÞ ¼ þ þ dr rðr þ aÞ rþa q ð1 N Þðr þ aÞ e Nbn w l E;N U þ Nr V V þ <0 rðr þ aÞ r
ð21Þ
The impact of severance payments on the society’s payoff H can be decomposed into three effects: the direct consequences due either to the loss of jobs or a reduction in profits and the indirect-equilibrium-consequences. The direct impact is captured by the second and the third term subsequent to the last equality sign in Eq. (21) and depicts the change in H for a given job acquisition rate. The second term describes the fall in profits due to higher expected red-tape costs of dismissals. The third term depicts the impact of a fall in employment. Every job loss reduces discounted tax receipts by wel/r and causes a utility
L. Goerke / Labour Economics 9 (2002) 497–512
507
change for a worker who becomes unemployed. As the utility stream of an employed worker VE,N must exceed the utility of an unemployed VU for anyone being willing to work, the overall effect is negative. Finally, the fall in the job acquisition rate (ar < 0) reduces the utility stream of employed and unemployed workers and also affects profits, as captured by the first term in square brackets in Eq._ (21). Since 1 N workers are without a job and will forego a utility increase of (VE,N w)/(r + a)2 if they remain so, the indirect effect of severance pay via the fall in the job acquisition rate is negative. The results can be summarised in Proposition 2: Proposition 2. The combined change in payoffs for firms, workers, and the government due to an economy-wide introduction of severance payments is negative. If employees favour the comprehensive introduction of severance pay, their gain will be greater than that of unemployed workers. 3.2. Redundancy pay The analysis of redundancy pay follows the same order as that of severance pay. First, the variations in payoffs due to an introduction of these payments at the firm level are looked at. Second, economy-wide redundancy payments are investigated. The changes in expected profits E(P), taking into account the wage variation, but holding constant the job acquisition rate a, are: dEðPÞ nh ½l n ¼ dS j da ¼ 0 r þ a
ð22Þ
While dismissal payments always decrease profits for a given level of wages, in the case of mass redundancies the wage falls and this reduction will be sufficient to raise profits if the tax l exceeds the firing cost mark-up f. Turning to workers, it can be noted that redundancy pay S will only alter the utility stream VU,D of a worker who loses the job owing to a small shock if s/he finds another job and loses the next one because of a large shock. However, the changes in wages and expected redundancy payments cancel out (cf. Eq. (6)), implying dVU,D/dS = 0 for da = 0. Workers who lose their job due to a collective dismissal benefit from redundancy pay (cf. Eqs. (5) – (7): dV U;M 1 >0 ¼ dS j da ¼ 0 r þ a
ð23Þ
Using Eqs. (2), (5), and (23), and dVU,D/dS = 0, the change in the utility stream of an employed worker due to redundancy payments, holding constant the outflow rate from unemployment, is found to be zero (dVE,N/dS = 0 for da = 0). Redundancy pay S leaves the
508
L. Goerke / Labour Economics 9 (2002) 497–512
utility of employed workers unaffected because the direct, negative wage effect exactly balances the increase in expected redundancy pay. Moreover, the utility if fired individually will be constant. Accordingly, employed workers are indifferent to the level of redundancy payments. This is because any change in expected redundancy payments is undone by a variation of the wage of the same magnitude but the opposite direction (cf. Eq. (6)). Such a wage adjustment ensures that the incentives to provide the required level of effort remain intact. Redundancy pay can increase the combined payoff of employed workers and the firm because the former are indifferent to such payments while a tax burden in excess of the firing cost mark-up in conjunction with a fall in wages implies that expected profits rise. Thus, redundancy payments for mass dismissals can be introduced at the firm level in a consensual manner, in contrast to severance payments for individual dismissals. The findings can be summed up in Proposition 3. Proposition 3. If employment rises with redundancy payments for collectively dismissed workers, an individual firm can negotiate a positive level with its workforce. If redundancy payments are introduced in the entire economy and raise employment per firm (l>n), the job acquisition rate will increase (aS>0). This entails higher wages and an uncertain impact on expected profits, that is, the sign of dE(P)/dS becomes indeterminate. The impact of a change in redundancy pay S on the utility stream VU,D of a worker who is dismissed individually can in analogy to the case of severance payments (cf. Eq. (16)) be derived as:
dV U;D d ¼ dS for l > n:
h 1 r
w þ qe¯ a þ r dS
i ¼
e¯ aS > 0 qr ð24Þ
An individually dismissed worker is better off due to redundancy pay for l>n, since it becomes more likely that s/he finds a new job. This raises the expected utility VU,D directly and also via the induced increase in wages (cf. Eq. (6)). The change in the utility stream VE,N of an employed worker can be derived from Eqs. (2), and (5) to (7) in the same way:
dV E;N e¯ ¼ aS > 0 qr dS
ð25Þ
The utility of an employed worker VE,N is unaffected by changes in redundancy pay S for a given job acquisition rate. A higher job acquisition rate (aS>0) reduces the utility loss from unemployment, since the efficiency wage increases and because VU,D rises with the
L. Goerke / Labour Economics 9 (2002) 497–512
509
reemployment probability a and the wage. Accordingly, redundancy payments will increase the utility stream of an employed worker for l>n if aggregate labour market effects are taken into account. As this positive externality can be internalised by introducing redundancy pay in all firms, the incentives to accept such payments become larger in contrast to a situation with a given job acquisition rate. Turning to an unemployed worker, the change in the utility stream VU due to redundancy pay will be positive if the tax rate exceeds _ the firing costs mark-up, implying aS>0, as the participation constraint requires VE,Nr>w. Moreover, a higher job acquisition rate also raises VU. dV U V E;N r w a dV E;N ¼ aS þ r þ a dS dS ðr þ aÞ2
ð26Þ
Eqs. (25) and (26) show that workers benefit from redundancy payments S irrespective of whether they currently have a job or not. However, the incentives for employed and unemployed workers to introduce redundancy pay S cannot be ranked. While the finding for severance payments—employed workers are more likely to support them than their unemployed counterparts—concurs with the results by Saint-Paul (2000, 2002), the potentially different impact for redundancy pay provides an additional argument for distinguishing between different forms of dismissal payments. Following the same methodology as for severance pay, the impact of introducing redundancy payments S on the combined payoff H of firms, workers, and the government can be calculated:
dH ð1 N ÞaS V E;N r w a¯e rh þ rbð1 þ nÞ þ hnS ¼ þ þN dS rþa q ð1 N Þðr þ aÞ rðr þ aÞ e Nhn wl þ NS V E;N V U þ rðr þ aÞ r
ð27Þ
Since the job acquisition rate and employment rise with redundancy pay S, all but the second term in Eq. (27) are positive. In contrast to severance pay, redundancy payments generate higher tax revenues and raise employment such that some formerly unemployed workers now obtain the utility stream from employment. This effect is captured by the third term in Eq. (27) in curly brackets. Moreover, the higher job acquisition rate raises the expected utility of current and future unemployed, as indicated by the expression in square brackets. Unless the increase in redundancy payments lowers profits strongly, because it implies higher dismissal expenditure due to the firing cost mark-up, the society’s payoff rises. This positive effect will be strengthened if the reduction in expenditure for unemployment compensation is taken into account. This yields Proposition 4.
510
L. Goerke / Labour Economics 9 (2002) 497–512
Table 1 Changes in payoffs—summary of comparative static effects for l>n Severance pay, r F Firm-level increase
Economy-wide increase
Redundancy pay, S
E
U
G
F
E
U
G
þ |fflfflfflfflfflfflfflfflffl{zfflfflfflfflfflfflfflfflffl}
+
?
þ |fflfflfflfflfflfflfflfflfflffl{zfflfflfflfflfflfflfflfflfflffl0}
0
?
? ?
? ffl{zfflfflfflfflfflfflfflfflffl?} |fflfflfflfflfflfflfflffl
+ ?
+ ?|fflfflfflfflfflfflfflfflfflffl{zfflfflfflfflfflfflfflfflfflþ ffl}
+a
F—firm; E—employed; U—unemployed; G—government. a Unambiguously positive effect requires sufficiently low firing cost mark-up.
Proposition 4. If employment rises with redundancy pay for collective dismissals, its economy-wide introduction will have ambiguous profit effects, while workers benefit. In the absence of additional firing costs (n = 0), the combined change in payoffs for firms, workers, and government is positive. 3.3. Comparison Propositions 1 –4 indicate that the changes in payoffs due to dismissal pay may depend crucially on whether detected shirkers can be excluded from these payments, as it has been argued to be the case for redundancy pay for collective dismissals but not for severance payments for individual dismissals. Moreover, the incentives for introducing dismissal pay at the firm level or for the entire the economy can differ. The variation in payoffs are summarised in Table 1.
4. Conclusions The theoretical predictions summarised in Table 1 are broadly supported by OECD (1999) evidence. With the exception of countries from southern Europe and Oceania, severance payments are generally close to zero unless workers have been employed in the same company for 20 years. Entitlements to redundancy payments seem to be more widespread. The analysis of this paper can be interpreted as a rationalisation of these features. Moreover, the predictions may provide insights into the empirical findings of differential unemployment effects of payments for individual and collective dismissals (Feld, 2001). However, severance payments for individual dismissals can be observed in many countries for workers with high tenure. In terms of the above model, this finding could be rationalised if the possibility of excluding shirkers from the receipt of severance payments for individual dismissals rises with tenure because work performance can be documented more precisely. If shirkers can generally be excluded from the receipt of severance payments to some extent, the negative employment consequences of severance payments will be weakened further. Finally, allowing for positive employment effects of
L. Goerke / Labour Economics 9 (2002) 497–512
511
severance pay in the absence of wage adjustments, by endogenising the extent of employment adjustments in the case of shocks, can enhance the incentives for their introduction.
Acknowledgements I am grateful for comments by Carsten Hefeker, Bernhard Boockmann, Guilio Piccirilli, and two anonymous referees as well as by participants of the annual meetings of the European Public Choice Society in Paris, the European Association of Labour Economists in Jyva¨skyla, and the 10th Silvaplana Workshop on Political Economy.
Appendix A Aggregate employment is determined using the steady-state condition h + b=(1 N)a/ N. Differentiation yields the expression in the main text. Substituting in Eq. (7), one obtains: bþh hSð1 N Þ e¯ Zuwe rþ e¯ w þ 1N rð1 N Þ þ ðh þ bÞN q hð1 N Þ r 1þ ¼0 ðIÞ rð1 N Þ þ ðh þ bÞN Aggregating over all s firms one obtains from Eq. (9): Y ¼ fˆ VðN Þ we ð1 þ lÞ
ðhS þ brÞð1 N Þð1 þ nÞ ¼0 rð1 N Þ þ ðh þ bÞN
ðIIÞ
The derivatives of Z and Y are given by Zw = 1, Yw = 1 l < 0, ZS = h/(r + a)>0, YS = (1 + n)h/(r + a) < 0, Yr = (1 + n)b/(r + a) < 0, " # bþh hðr SÞ e¯ ðr þ a þ hÞ < 0; and ZN ¼ < 0 ; Zr ¼ 2 2 rþa q ð1 N Þ ðr þ aÞ ðh þ bÞðhS þ brÞð1 þ nÞ YN ¼ fˆ W¯e þ : ðr þ aÞ2 ð1 N Þ2
ðIIIÞ
The determinant of the system will unambiguously be negative if j = 0 and A z s or j = S = 0, that is in any case if dismissal are introduced. The changes in aggregate employment N due to higher dismmissal pay for YNZw ZNYw < 0 are: dN hðn lÞ=ðr þ aÞ ¼ > 0 for l > n dS YN Zw ZN Yw
ðIVÞ
512
L. Goerke / Labour Economics 9 (2002) 497–512
dN bð1 þ nÞ þ ð1 þ lÞ½r þ a þ h ¼ <0 dr ðr þ aÞðYN Zw ZN Yw Þ
ðVÞ
References Addison, J.T., Teixeira, P., The economics of employment protection. Journal of Labor Research, in press. Bentolila, S., Bertola, G., 1990. Firing costs and labor demand: how bad is eurosclerosis? Review of Economic Studies 57, 381 – 402. Bertola, G., 1999. Microeconomic perspectives on aggregate labor markets. In: Ashenfelter, O., Card, D. (Eds.), Handbook of Labor Economics, vol. 3c. North-Holland, Amsterdam, pp. 2985 – 3028. Booth, A.L., 1997. An analysis of firing costs and their implications for unemployment policy. In: Snower, D.J., de la Dehesa, G. (Eds.), Unemployment Policy: Government Options for the Labour Market, Cambridge Univ. Press, Cambridge, pp. 359 – 388. Bull, C., 1985. Equilibrium unemployment as a worker discipline device: comment. American Economic Review 75, 890 – 891. Burda, M.C., 1992. A note on firing costs and severance benefits in equilibrium unemployment. Scandinavian Journal of Economics 94, 479 – 489. European Industrial Relations Review (EIRR), 1999. Individual Dismissals in Europe, Parts 1 – 3, 306: 30 – 36, 308: 20 – 23, 311: 31 – 35. Emerson, M., 1988. Regulation or deregulation of the labour market: policy regimes for the recruitment and dismissal of employees in industrialised countries. European Economic Review 32, 775 – 817. Feld, L., 2001. Growth, Unemployment, Investment, and Employment Protection Legislation: Panel Evidence for the EU-12 from 1970 to 1996. Mimeo, University of St. Gallen. Fella, G., 2000. Efficiency wages and efficient redundancy pay. European Economic Review 44, 1473 – 1490. ¨ konomie (Labour law and economics). Recht der Arbeit, 32 – 38. Franz, W., Ru¨thers, B., 1999. Arbeitsrecht und O Garibaldi, P., Violante, G.L., 1999. Severance Payments in Search Economies with Limited Bonding. Mimeo, University College London. Goerke, L., 2000. On the structure of unemployment benefits in shirking models. Labour Economics 7, 283 – 295. Goerke, L., 2002. Taxes and Unemployment. Kluwer Academic Publishers, Boston. Lazear, E.P., 1990. Job security provisions and employment. Quarterly Journal of Economics 105, 699 – 726. OECD, 1986. Non-wage labour costs and employment. Employment Outlook, OECD, Paris, 80 – 85. OECD, 1999. Employment protection and labour market performance. Employment Outlook. OECD, Paris, 47 – 132. Picard, P.M., Toulemonde, E., 2001. On the equivalence of taxes paid by employers and employees. Scottish Journal of Political Economy 48, 461 – 470. Saint-Paul, G., 1995. Efficiency wage, commitment and hysteresis. Annales d’Economie et de Statistique 37/38, 39 – 53. Saint-Paul, G., 1996. Exploring the political economy of labour market institutions. Economic Policy 11, 265 – 315. Saint-Paul, G., 2000. The political economy of labour market institutions. Oxford Univ. Press, Oxford. Saint-Paul, G., 2002. The political economy of employment protection. Journal of Political Economy 110, 672 – 704. Shapiro, C., Stiglitz, J.E., 1984. Equilibrium unemployment as a worker discipline device. American Economic Review 74, 433 – 444.