Job Security Does Affect Economic Efficiency : Theory, a New Statistic, and Evidence from Chile

The extensive empirical macro- and micro-level evidence on the impact of job security provisions is largely inconclusive. We argue that the weak evidence is a consequence of the weak power of statistics used, which is suggested by a dynamic theory of plant-level labor demand that we develop. This model speaks clearly on one issue: firing costs drive a wedge between the marginal revenue product of labor and its marginal cost. We examine changes in this gap as our test statistic. It is easy to compute and has a welfare interpretation. We use census data of Chilean manufacturing firms for the years 1979-1996 to look for real effects induced by two significant increases in the costs of dismissing employees. Similar to previous findings in other data, the traditional labor demand statistics provide little evidence of a negative impact from increases in firing costs. While we find no evidence that gaps increase for inputs that are not directly affected by firing costs, we find large and statistically significant increases in the mean and variance of the within-firm gap between the marginal revenue product of labor and the wage for both blue and white collar workers