Experience Rating versus Employment Protection Laws in a Model where Firms Monitor Workers

While layoff costs in the U.S. are mostly due to experience-rated unemployment insurance, layoff costs in European labour markets are primarily a consequence of employment protection laws. In this paper we compare the effects of experience rating and employment protection laws on employment and welfare in a model where unemployment arises due to efficiency wage setting and where labour turnover is inefficiently high. We show that a revenue-neutral introduction of experience rating reduces labour turnover and increases employment and welfare. The introduction of employment protection laws may also reduce labour turnover but employment declines. Copyright The editors of the "Scandinavian Journal of Economics", 2005 .