Employment protection and misallocation of resources across plants: International evidence

Employment protection affects aggregate productivity via several channels in potentially contradicting ways, which makes it difficult to establish the relationship between the two. This study focuses on the misallocation of production factors across plants, which has been shown in past studies to substantially reduce aggregate productivity. The study provides new evidence on the effect of employment protection on resource misallocation using a large data set of manufacturing plants covering more than 90 countries. For measuring misallocation, I use the within-industry dispersion of the marginal product of labor and total factor productivity. The results show that higher cost of dismissing redundant workers is positively associated with misallocation. This effect appears to be larger in industries that have greater demand for adjusting labor, that is, in industries with intrinsically high layoff rates, and in expanding or shrinking industries.

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