Permanent uncertainty, employment protection, and firms'location

It is often argued that firms need flexibility in order to better face demand uncertainty. As employment protection legislation (EPL) impacts the cost of volume adjustments available to firms, it constrains the volume flexibility that they can achieve. Weakening EPL might thus be thought of as a desirable policy, in particular for when firms are deciding where to locate. On the other hand, it is well known that in an oligopolistic setting, flexibility is not necessarily an advantage. The aim of this paper is to analyze the consequences that different EPL regimes may have on firms' location decisions. It shows that the country characterized by the strongest EPL can nevertheless attract firms under demand uncertainty (either in an agglomeration equilibrium, or in a dispersion equilibrium), and highlights the respective and combined roles played by trade costs and strategic interaction. Moreover, it shows that if firms compete in prices, they will never agglomerate in the country with the lowest EPL.