The Unemployment Implications of Mandatory Firing Costs

The model developed in this paper examines the relationship between firing costs and unemployment in a simple two-period model with uncertainty. Where there are long-term employment relationships, and where risk-averse workers and risk-neutral firms bargain over wages and firing costs, average unemployment is unlikely to be affected by statutory firing costs, although firms' profits will decline if the statutory level exceeds the bargained level. In a unionised sector with no bargaining over firing costs, the presence of statutory firing costs reduces employment distortions associated with trade unions. However, where there are no gains to employers to long-term labour relationships, the introduction of mandated firing costs will be associated with a higher incidence of temporary employment contracts and short-term jobs.