THE WELFARE EFFECTS OF FIRING RESTRICTIONS

I investigate the extent to which firing restrictions could serve as a welfare-improving contractual arrangement between the firm and the worker. I present a model where the equilibrium level of severance payment (and notice period) is equal to the welfare loss of the fired worker, and this induces the firm to make the efficient firing decision. The welfare loss of the fired worker in turn depends on the degree of wage inflexibility, the unemployment duration, and the unemployment benefit. I examine the labor data for OECD countries, and find that the the level of severance payment and notice period is comparable to the welfare loss of the fired worker, as the model suggests. In the immedate future, I will calibrate the model and estimate the (socially) optimal level of severance payment and notice period in individual OECD countries. JEL classification: J60; J63; J6