DP3430 | A Pure Theory of Job Security and Labour Income Risk


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Models of labour market equilibrium where forward-looking decisions maximize both profits and labour income on a risk-neutral basis, offer valuable insights into the effects of employment protection legislation. Since risk-neutral behaviour in the labour market presumes perfect insurance, however, job security provisions play no useful role in such models. This Paper studies a stylized model of dynamic labour market interactions where labour reallocation costs are partly financed by uninsured workers? consumption flows. In the resulting second-best equilibrium, provisions that shift labour reallocation costs to risk-neutral employers can increase productive efficiency if their administrative deadweight costs are not too large, and increase workers? welfare as long as employers? firing costs at least partly finance workers? mobility.