The Costs That Do Not Appear in the Unemployment Rate

Employment protection legislation changes more than the number of people recorded as unemployed. This chapter evaluates the protection gap between open-ended and temporary employment through job flows, earnings, training, and productivity. The aim is to separate what the evidence can support from what a single unemployment figure cannot show: a labour market may be busy with hiring and still offer weak security, poor skill accumulation, and little movement into stable work.

That distinction is necessary because the effects of EPL do not run in one direction. Stronger protection can reduce arbitrary dismissal and encourage a firm and its workers to invest in a longer relationship. It can also raise the cost of adjustment, slow movement toward more productive uses of labour, and encourage firms to place flexibility in temporary contracts. The outcome depends on which channel dominates and on how the rules are distributed across the workforce.

Employment can be moving without becoming more secure

The broad evidence does not show a clear general relationship between the strictness of employment protection legislation and the unemployment rate. That finding is easy to misread. It does not mean that EPL has no labour-market effect. It means that the effects can offset one another or appear in margins that the unemployment rate does not measure.

When dismissal is costly, a firm may dismiss fewer existing workers. That protects people already inside the firm, at least in the short run. But the same cost can make the firm more cautious about hiring, because a decision to expand today is harder to reverse tomorrow. Higher firing costs can therefore reduce both job destruction and job creation. The labour market may become less fluid without producing a simple, predictable change in the unemployment stock.

Temporary work changes that picture. If open-ended employment is difficult to end but temporary hiring remains comparatively easy, the firm can adjust through a workforce whose contracts expire or can be ended with fewer obligations. Hiring and separation may then be frequent among temporary workers even while open-ended workers experience low turnover. At the aggregate level, the labour market looks active. At the individual level, the movement may consist of repeated short spells rather than progress toward a more secure position.

This is why job flows are more informative than a single stock measure for the question at hand. A hiring rate tells us that someone entered a job. A separation rate tells us that a job ended. Neither tells us whether the worker acquired training, accumulated tenure, moved to a better employer, or returned to another temporary contract. The protection gap can increase the number of transitions while lowering the quality and predictability of those transitions.

The apparent contradiction is especially sharp in a dual labour market. The protected workforce may have fewer dismissals and fewer new entrants, while the temporary workforce experiences frequent hiring and separation. The two groups are not moving through the same system. The first is insulated from some shocks; the second absorbs them.