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Employment protection may reduce productivity by distorting production choices. Firms facing firing costs will substitute labor with capital and retain unproductive workers. To test these theoretical predictions we consider a reform that introduced unjust-dismissal costs in Italy for firms below 15 employees, leaving firing costs un-changed for bigger firms. Using establishment-level data from the Centrale dei Bilanci of the Bank of Italy our analysis provides evidence of capital deepening and a decline in total factor productivity following the introduction of higher firing costs in firms below 15 employees