Dani Rodrik links to an interesting literature review which discusses the lack of evidence establishing a causal relationship between Europe’s heavily regulated labor market and Europe’s high unemployment. I found Dr. Rodrik’s alternative analysis of firing restrictions interesting:
In at least one area of labor-market intervention, employment protection (firing restrictions), the orthodox expectation is not the only “logically consistent” story that accords with economic intuition. If you make it harder to fire an employee, you essentially give that employee some property rights over the job he occupies. Now, according to the Coase theorem, how property rights are allocated (to the employer versus the employee) has no effect on efficiency in the absence of bargaining and other transaction costs. If eliminating a job is the efficient thing to do, an employer can do it either by fiat or by paying the employee to leave. There are distributional implications (obviously the employer is worse off in the latter case), but nothing to stop the efficient thing from getting done. This is an idea I associate with my Harvard colleague Richard Freeman.
At first, the Coasian perspective seemed like a useful one, but after considering it, I think it is inappropriate or at least incomplete.
As Dr. Rodrik suggests, one way to look at firing restrictions is as giving employees property rights over their job or, more specifically, property rights over their pay. However, Dr. Rodrik is wrong to assert that such restrictions have no consequences for efficiency, because in the long run, firing restrictions do not affect the initial allocation of ownership rights but the sorts of employment relationships which are allowed. It is impossible to arrange for anyone but the employer to have the initial allocation of job rights, without abolishing employers altogether, simply because the employer creates the position and decides who to hire. Instead of changing the initial allocation of property rights, firing restrictions limit the types of employment relationships that are allowed to those that involve a full transfer of pay rights from the employer to the employee. Now the neoclassical analysis, that Dr. Rodrik discusses, applies completely. Employers face information asymmetry and employees have credibility problems, so employers are reluctant to hire.
The short run is a little different. In the short run, if the creation of firing restrictions were sudden, there would be a reassignment of property rights from employers to employees and a corresponding redistribution which may be desirable. Such a sudden and arbitrary reassignment of property rights should not be taken lightly, however, because it would be a massive violation of the rule of law, and we should always be wary of violations of the rule of law.
I would like to read Richard Freeman; perhaps my analysis is too shallow.
Note: For some reason, I thought Dr. Rodrik was Hispanic for some reason, but, apparently, he is from Turkey.