Hiring and firing costs can influence innovative firms by affecting investment and expansion. For example, onerous regulations preventing the employment of foreign workers can make it difficult to recruit skilled people. As the size of a business increases, the costs of hiring and firing may inhibit the firm from expanding further. Changing, unclear and complex regulation can discourage companies from hiring new employees.

 

High costs in firing are likely to affect a company’s willingness to take risks and experiment with growth opportunities. In fact, firms may be less willing to expand their workforces and to enter into new markets if they cannot shrink their workforces when their strategies prove unsuccessful. An aversion to risk taking leads to more conservative growth strategies, which reduces productivity. This can be particularly detrimental for innovative industries, which tend to be more risky and volatile. As a consequence, countries with greater worker protection and thus higher firing costs may specialize in industries that are less innovative or that rely on older technologies, since more dynamic industries have to be prepared to adjust their workforce (Samaniego, 2006). Also, innovators in countries with high firing costs may tend to specialize in “secondary innovation” that improves existing products, rather than “primary innovation” that introduces new products (Saint-Paul, 2000) and requires organizational change. Furthermore, high firing costs may create additional sunk costs, i.e. upfront costs incurred that cannot be recovered ex post, for emerging firms; redundancy pay, for instance, increases the risk of economic losses in the event of insolvency (Kanniainen and Vesala, 2005).

 

Stringent labour market regulations and high firing costs may prevent an efficient reallocation of human resources and reduce job turnover across firms. Therefore, strict EPL may be an obstacle to creative destruction, an important process through which countries create new jobs and increase their productivity (OECD, 2009; Bartelsman, Haltiwanger and Scarpetta, 2009; Bravo-Biosca, Criscuolo and Menon, 2013). Creative destruction, if it is to have a positive effect, depends on reallocating and redistributing those resources that are destroyed.

 

The negative link between innovation and EPL is controversial. Firms that invest significantly in training and share tacit knowledge may benefit from stringent EPL, as they can take advantage of lower rates of labour turnover and increase their return on investment (Acharya et al., 2010); similarly, stringent EPL, acting as an implicit insurance, may encourage workers to be more willing to engage in innovative and risky projects. Furthermore, efficiency wage theories suggest that workers may perceive EPL as an upgrade in the quality of their employment, which may lead them to increase their efforts and have a positive effect on innovation.

 

 

There is a general consensus in the economic literature about the negative effects of EPL on job reallocation, with evidence available both within and across countries (Bertola, 1990; Haltiwanger et al., 2006; Gomez-Salvador et al., 2004; Kugler and Pica, 2008).

 

The direct effect on firms’ performance is more debatable. Bassanini et al. (2009) find that mandatory dismissal regulations have a depressing impact on productivity growth in industries where layoff restrictions are more likely to be binding. However, Martin and Scarpetta (2012) extensively examine recent empirical evidence to conclude that stringent EPL has a sizeable negative effect on labour flows and, in consequence, on aggregate productivity growth.

Employment protection legislation can be directly affected by policy. It is important that labour market and social protection policies facilitate, rather than hinder, innovative projects.

 

Labour market policies targeting workers rather than jobs can be valuable. Workers should be especially sustained during unemployment spells and job-to-job transitions, and should be helped in converting their skills. The degree of uncertainty in dismissals should be minimized by reducing cases where legal action is required and by reducing delays when such action is needed.

 

Labour market legislation has to cover a wide range of different situations and therefore needs to be carefully framed in order to avoid becoming a disincentive. A single organisation responsible for information, inspection and enforcement can be useful in that context.

 

Transition periods for new legislation and readily available information about changes in legislation can make it easier for companies to deal with regulations.

 

In order to avoid problems with a new employee, systems can be put in place to subsidise the costs of initial employment and possibly to assist with recruitment.

 

To avoid uncertainty for employers regarding possible claims for unfair dismissal, there can be clear limits to compensation, while the complaint process can be simplified and made less costly through operation of an arbitration service.