The Political Economy of Employment Protection

Abstract

This paper develops a model of job creation and job destruction in a growing economy with embodied technical progress, which I use to analyze the political support for employment protection laws such as the ones that are observed in most European countries. In voting in favor of employment protection, incumbent employees trade off lower living standards (because employment protection maintains workers in less productive activities) against longer job duration. The latter is valued because the employed have rents, achieving wages above their alternative value. The gains from, and consequently the political support for, employment protection are larger the lower the rate of creative destruction (i.e., the lower the growth rate) and the larger the employed's bargaining power. Hence, employment protection is more likely to arise in economies with greater worker bargaining power. Also, workers in older vintages are more in favor of employment protection. Consequently, greater initial protection increases its own support by maintaining a larger fraction of the workforce in older vintages. Finally, if workers can invest ex ante in match-specific human capital, multiple steady-state political equilibria may arise, as the outcome of the mutual feedback between employee rents and employment protection.