Prime Minister’s Economic Bureau and FEDEA

We document the presence of a trade-off between unemployment benefits (UB) and employment protection legislation (EPL) in the provision of insurance against labor market risk. Different countries ’ locations along this trade-off represent sta-ble, hard to modify, politico-economic equilibria. We develop a model in which individuals determine the strictness of EPL and the size of a redistributive UB system in two distinct political environments. Agents are heterogeneous along two dimensions: employment status — insiders and outsiders — and skills — low and high. Unlike previous work on EPL, we model employment protection as an institution redistributing also among insiders, notably in favour of the low-skill workers. A key implication of the model is that flexicurity configurations with low EPL and high UB should emerge in presence of dispersed wage structures and progressive UB systems. Micro data on wage dispersion display correlations consistent with our results. The analysis of the experience of EPL reformers yields results which are in line with the relation between EPL and progressiveness of the UB system implied by our model