Wednesday, February 13, 2008

Protecting Jobs...

"If a country passes laws that make it difficult for firms to fire workers, why will that generally increase the unemployment rate?" - Louis

That's an excellent question! Consider the problem of the firm. They face uncertainty about the future demand for their output. Suppose demand increases today. The employer may wish to hire additional workers, but must take into account that future demand will also vary. In particular, future demand may fall sufficiently that the firm may wish to lay off the worker that they've just hired.

Suppose the Government passes a law that states that firms cannot lay off workers under any circumstances. Now let's work backwards from this. The employer knows that if he hires a worker today he will need to pay that worker tomorrow, whether he needs the worker tomorrow or not. Because there is a non-trivial chance that he would want to fire the worker tomorrow, he will be more hesitant to hire the worker today.

Legislation the makes it difficult for firms to fire workers therefore result in higher unemployment, as employers in general will be more hesitant to hire workers. But not everyone losses: people in existing jobs are better off (they currently have jobs, and therefore cannot be fired), but people who currently do not have jobs but may wish to enter the labour market in future (like my students) are worse off: employers will be mush more hesitant to hire them.

This suggests another problem resulting from firms being unable to fire workers. Younger people already have the highest unemployment rates (for example, in Hong Kong the unemployment rate for 15-19 year olds is 16.6%; it falls to 4.4% for 20-29 year olds and 2.4% for 30-39 year olds). Also younger people are more likely to be freshly entering the work force. Thus restricting firms' ability to fire workers is likely to exascerbate youth unemployment. This is both socially and economically costly.

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