DP1571 | The Rise and Persistence of Rigidities

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21/02/1997

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Abstract

In this paper we argue that employment protection legislation is more likely to arise when the rents earned by the employed over their alternative wage is greater. The model explains why economies with greater real wage rigidity also have greater employment protection. The model also predicts that lower turnover increases the political support for employment protection and that this political support is greater when employment protection is more harmful for employment. Also, rigidities are persistent as they create a constituency of low-productivity sectors whose workers would oppose the removal of firing costs, even though existing rents would not generate support for introducing them. We argue that tight labour markets due to post-war reconstruction needs in Europe made it easier for insiders to create such rents, which in turn led them to support employment protection legislation. In the late 1970s, rents started to fall but reforms proved difficult because of ratchet effects.