More Proof: Employment Protection Does Not Affect Employment

The OECD has just released its 2013 Employment Outlook.  In addition to its usual overview of labour market developments, Chapter 2 of this year’s report reports on a thorough revision and updating of the OECD’s quantitative index of employment protection legislation (EPL). The chapter contains a useful summary of the mainstream literature regarding EPL costs and benefits – although this would have benefited from inclusion of the important heterodox voices who have written about on the employment effects of labour market institutions (such as Baker, Glyn, Howell, and Schmitt).  Chapter 2 also contains a detailed review of the revised methodology behind the OECD index.

The actual country scores for the index do not seem to be reported in the chapter, but they are available through the OECD’s online employment database.

The key findings of Chapter 2 include:

• EPL is generally stronger regarding mass layoffs than individual dismissals.
• Cross-country variations are especially wide regarding regulations on temporary work and temporary agencies.
• Countries in the common-law tradition generally have weaker EPL.
• Countries with stricter rules regarding termination generally demonstrate a more activist approach to other labour market regulations (duh!).
• There is a clear trend toward weakening of EPL standards, with over one third of OECD countries cutting their standards since 2008.
• Especially in the common-law countries, there are virtually no policy limitations on the use of temporary contract workers, temporary help agencies, and other manifestations of the precarious labour market.

Countries with very weak employment protection rules include New Zealand (with the worst score), the U.S., Canada, and the U.K.  In these countries (following the British common-law tradition), there is very little policy protection for dismissed workers, who are left to pursue their own individual redress through the courts (a system that might work for high-income individuals with the cash and patience to undertake that type of action, but not for the vast majority of workers).  Countries with the strongest EPL standards include Turkey, Luxembourg, France, Belgium, Italy, Mexico, and Germany.  Among emerging economies reviewed by the OECD study, Argentina and China have the strongest EPL rules.

The standard neoclassical story is that stronger EPLs inhibit the “flexibility and efficiency” of market forces, resulting in less and poorer employment in the long-run (thus self-defeating the nominal purpose of EPL, which is to “protect employment”). There’s no evidence of that correlation in the OECD data, however. The US, of course, has had one of the worst-performing labour markets in the OECD in recent years – despite its extremely weak labour protections in all areas. Some countries with strong EPL have achieved very good labour market outcomes (such as Germany).

A simple comparison of the average EPL score for each country versus the change in its employment rate from 2008 through 2012 (also reported in the OECD Employment Outlook’s statistical annex) is provided below.  [Change in the employment rate is a better indicator of employment performance across countries, especially during recessionary times; in contrast, the unemployment rate is distorted by factors such as growing non-participation, eligibility for unemployment benefits, and other factors, and hence provides a misleading indication of labour market utilization.]

There is no statistically significant correlation between intensity of EPL and labour market performance. According to the neoclassical story, there should be a clear negative pattern to the graph (with countries with weaker EPL enjoying stronger jobs growth relative to population). In fact, the linear trend of the 34 observations suggests a weak (statistically insignificant) positive relationship. The 7 OECD countries with the strongest EPL frameworks according to the OECD all outperformed the linear trend illustrated on the graph (in other words, they would demonstrate a positive residual in a simple regression of employment rate changes on the level of EPL protection).  Four of those countries (Germany, Luxembourg, Turkey, and Mexico) were among the handful of OECD countries in which the employment rate actually increased between 2008 and 2012.  This finding is fully consistent with the heterodox research (such as that cited above) which finds no systematic impact one way or the other of labour market interventions (including EPL) on employment outcomes; instead, it is demand-side factors which are the crucial determinant of employment.

So it turns out that restricting the power of companies to terminate existing workers, and replace them with precarious staff, might actually be good for the labour market after all. It is certainly good for workers.