Employment protection and capital-labor ratios
Sciences Po LIEPP Working Paper
Paris : Laboratoire interdisciplinaire d'évaluation des politiques publiques
Sciences Po LIEPP Working Paper : 33
Employment protection (EPL) has a well know negative impact on labor flows as well as an ambiguous but often negative effect on employment. In contrast, its impact on capital accumulation and capital-labor ratio is less well understood. The available empirical evidence suggests a non-monotonic relation between capital-labor ratios and EPL: positive at very low levels of EPL, and the negative. We explore the theorical effects of EPL on physical capital in a model of a firm facing labor frictions. Under standard assumptions, theory always implies a motononic negative link between capital-labor ratios and EPL. For a positive link to arise, a very specific pattern of complementarity between capital and workers protected by EPL (senior workers as opposed to unprotected new entrants, or junior workers) has to be assumed. Further, no standard production technology is able to reproduce the inverted U shape pattern of the data.