The dynamics of labor markets in Europe and the US: Specific skills or employment protection?

We argue that the main difference between European and American labor markets is not so much in the unemployment rates, but maybe more importantly in the reduced flows into and out of unemployment, in Europe. Employment protection legislations (EPL) have been extensively studied in the literature to account for such differences. We emphasize a new channel through which EPL affect transitions. The presence of costly firing regulations increases job tenure and thus raises the expected duration over which any (match specific) investment can be recouped. Because of EPL, more stable matches will increase the incentive to accumulate SHC; but also more productive matches will be broken less frequently. This channel is introduced in Wasmer (2006), but we generalize it in a calibrated model of both quits and layoffs. The resulting implication that more "sclerotic" markets may feature more productive employed workers is broadly verified by looking at worker productivity figures in Europe and the U.S. A by-product of the paper is to develop a model which distinguishes quits from layoffs, based on asymmetric information between workers and firms. The model exhibits convenient close-form solutions reminiscent of complete information axiomatic bargaining theory