How Effective Are Firing Costs?

This paper derives the effect of state-mandated redundancy payments on a firm's firing decision as a function of the characteristics of its stochastic environment. We both summarize the main determinants of the effectiveness of firing costs using numerical simulations and point out some important considerations in evaluating their significance. In particular, we find that the effect of firing costs is very sensitive to the rate of growth of productivity, the rate of interest, workers' quit rate and the persistence of productivity shocks in addition to the level of uncertainty. The fall in trend productivity growth in the past two decades, accompanied by a rise in real interest rates and a possible increase in the persistence of labour demand shocks should have made employment more sensitive to cyclical downturns.