COWLES FOUNDATION FOR RESEARCH IN
ECONOMICS Box 208281
COWLES FOUNDATION DISCUSSION PAPER NO. 1480 Effective Labor Regulation and Microeconomic Flexibility Ricardo J. Caballero, Kevin N. Cowan, Eduardo M.R.A. Engel and Alejandro Micco September 2004 Microeconomic flexibility is at the core of economic growth in modern
market economies because it facilitates the process of creative-destruction, The main
reason why this process is not infinitely fast, is the presence of adjustment costs, some
of them technological, others institutional. Chief among the latter is labor market
regulation. While few economists object to the hypothesis that labor market regulation
hinders the process of creative-destruction, its empirical support is limited. In this
paper we revisit this hypothesis, using a new sectoral panel for 60 countries and a
methodology suitable for such a panel. We find that job security regulation clearly
hampers the creative-destruction process, especially in countries where regulations are
likely to be enforced. Moving from the 20th to the 80th percentile in job security, in
countries with strong rule of law, cuts the annual speed of adjustment to shocks by a
third while shaving off about one percent from annual productivity growth. The same
movement has negligible effects in countries with weak rule of law. |
