4/2013 Liina Malk. Relaxation of employment protection and its effects on labour reallocation

Working Papers of Eesti Pank No. 4/2013

Published in International Journal of Manpower, 2014, 35 (6)

Flexibility of employment protection is considered to be essential for rapid adjustments in the workforce to changing economic conditions and for the reallocation of labour towards more productive activities. This was one of the main arguments for the new Employment Contracts Act in Estonia, which eased employment protection by reducing the costs of terminating employment relationships. Since such substantial changes in employment protection legislation (EPL) are quite rare, this reform provides a good chance to examine the outcomes of the relaxation of employment protection. This paper evaluates the effects of this institutional change on labour reallocation. Exploiting the microdata of the Labour Force Surveys for the years 2007–2011, we analyse worker flows and employ the difference in differences approach to identify the effects of the EPL reform, using Lithuanians as a control group for Estonians. Subsequent to the reform, labour flows out of and into employment increased in Estonia relative to Lithuania. However, from the regression analysis, a statistically significant impact of the EPL reform was identified only on the former of these two types of flows. Both the assessment of aggregate flows and the estimation of difference in differences effects for transition probabilities indicate that the reform of employment protection resulted in lower job-to-job flows while the overall effect on labour reallocation was positive.

JEL Code: J60, K31

Keywords: employment protection legislation, labour reallocation, policy evaluation, difference in differences estimation.

Author’s e-mail address: Liina.Malk [at] eestipank.ee

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The views expressed are those of the authors and do not necessarily represent the official views of Eesti Pank.