Job Protection Deregulation in Good and Bad Times

This paper explores the short-term employment effect of deregulating job protection forregular workers and how it varies with prevailing business cycle conditions. We apply a localprojection method to a newly constructed 'narrative' dataset of major regular job protectionreforms covering 26 advanced economies over the past four decades. The analysis relies oncountry-sector-level data, using as an identifying assumption the fact that stringent dismissalregulations are more binding in sectors that are characterized by a higher 'natural' propensityto regularly adjust their workforce. We find that the responses of sectoral employment to largejob protection deregulation shocks depend crucially on the state of the economy at the timeof reform--they are positive in an expansion, but become negative in a recession. Thesefindings are consistent with theory, and are robust to a broad range of robustness checksincluding an Instrumental Variable approach using political economy drivers of reforms asinstruments. Our results provide a case for undertaking job protection reform in good times,or for designing it in ways that enhance its short-term impact