Employment Protection and Labor Productivity: Positive or Negative?

Since the 1980s, many European countries have implemented labor market reforms, introducing more flexible labor contracts. This paper develops a matching model with heterogeneous matches in order to analyse the impact of employment protection on labor productivity. Several channels affects productivity. On one hand, flexible contracts reduce mismatching: low productive jobs are destroyed at no cost with a positive impact on the overall productivity. On the other hand, they imply lower human capital investment, reducing labor productivity. We analyze a third channel: the selection of the employees. Low costs of dismissal reduce the incentive of firms to\ninvest in screening applicants, therefore increasing the uncertainty about their unobserved skills and productivity.