The Short-Term Employment Costs of Regulatory Reforms

[We’re pleased to welcome authors Dr. Andrea Bassanini of the Organisation for Economic Co-operation and Development (OECD) and Federico Cingano Bank of Italy.  They recently published an article in the ILR Review entitledBefore it Gets Better: The Short-Term Employment Costs of Regulatory Reforms,which is currently free to read for a limited time. Below, they reflect on the inspiration for conducting this research:]


Despite their being understood as powerful tools to promote and sustain economic growth, the pace of structural reforms slowed down during the recent recession and subsequent sluggish recovery (OECD 2016; IMF 2016a). These trends have partly been traced to increasing concerns that such reforms may entail costly transitory adjustments whose burden becomes especially worrying in periods of persistent economic and employment slack.
But are such concerns grounded? Surprisingly, not much is known as to their actual relevance or, perhaps more importantly, as to whether appropriately designed policies could help attenuating them (see Boeri et al, 2015; IMF 2016b).

In “Before it gets better: The Short-Term Employment Costs of Regulatory Reforms”, A. Bassanini (OECD) and F. Cingano (Bank of Italy) looked at the employment consequences of reforms removing barriers to entry in product markets (PMR reforms) and lowering the cost of dismissals (EPL reforms). Drawing on more than 30 years of cross-country industry and regulation data, they show that both reforms entail non-negligible – though transitory – employment losses on average. A reduction of barriers to entry in network industries, for example,  induces industry employment to fall below its pre reform level during the first three years. Similarly, one year after the “average” reform of dismissal legislation employment in dismissal intensive industries is around 0.5% below its pre-reform level (relative to other industries).

These negative short-term consequences can be contained, according to the analysis. For one thing, employment losses turn out to be smaller, if not negligible, for product and labour market reforms implemented during economic upswings. When aggregate output is growing above its potential, as usually occurs in the years following a recession period, hiring is scaled up while there are few inefficient jobs to be destroyed.
Moreover, the costs of easing dismissals legislation are negligible when product market regulation is light. Because the reverse does not hold (the costs of lowering entry barriers are found to be higher when employment legislation is light) the analysis suggests that a highly regulated country interested in reforming both domains could minimize the short-term costs of its policy package by deregulating product markets before the labor market.

Finally, the paper finds that employment losses from reforms of EPL for regular, open-ended contracts are less acute in countries with significant labour market dualism, where volatile positions are typically filled with temporary contracts. This result is remarkable because lowering dismissal regulation on permanent contracts is probably the single most effective way to tackle segmentation between protected permanent contracts and precarious temporary contracts (see OECD, 2014). In other words, EPL reforms are likely to come at no cost (on employment) in those countries where they will bring the greatest benefits (on duality).

These findings are obtained accounting for a number of confounding factors including country-industry trends (capturing specialization patterns, trends in regulation), country specific yearly shocks (capturing the business-cycle, “waves” of reforms, etc.) and industry specific shocks (as technology or demand shocks). They also proved robust to a large set of specification and sensitivity checks, to tests for reverse causality and to using in political variables as instrument for changes in regulation.


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