CONSTRAINTS ON ECONOMIC GROWTH: TOUGHER RESTRICTIONS ON HIRING AND FIRING PREVENT FIRMS FROM ADOPTING THE LATEST TECHNOLOGIES

Firms in European countries with tougher regulations on hiring and firing workers are less likely to adopt new technologies and operate in sectors with a high number of highly-skilled workers than firms in countries with lower levels of regulation. This has profound consequences for economic growth.

These are among the findings of a pan-European study by Maurizio Conti and Giovanni Sulis.Their research, to be presented at the Royal Economic society’s 2011 annual conference, looks at around 50 manufacturing and services sectors for 15 EU countries over the past 40 years. It finds that:

  • Firms that rely on technology and high-skilled workers grow more slowly in countries with tough labour rules than similar firms in less strict countries.
  • Within countries, the difference in growth between the companies that use more technology and those that use less, such as between car production and tobacco production, is lower for countries with strict regulations like Greece compared with countries with more relaxed rules like Austria.
  • Countries with high firing costs tend to specialise in sectors with low shares of high-skilled employees and low rates of adoption of new technologies.
  • This can help explain the different growth rates among European countries. In the past 15 years, those countries with sluggish growth are those counties less likely to adopt new technologies because of tighter labour restrictions. This effect has strengthened over time as the role of technology in determining economic growth has risen.

It is widely recognised that having a highly-skilled workforce is requirement for the successful introduction and exploitation of new technologies such as ICT and automated machinery. These technologies in turn are a major factor in determining economic growth. The cross-country difference in growth rates within Europe in particular has been exposed by the recent global crisis.

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It is widely recognised by economists that having a highly skilled workforce is a necessary condition for the successful introduction and exploitation of new technologies such as information and communication technologies (ICT) and automated machineries. Allowing firms to reorganise their production processes by moving towards less hierarchical management practices and more decentralised decision-making procedures, new technologies have been found to play a non-negligible role in driving the growth process in some countries.

But these reorganisation processes often need to proceed through trials and errors and therefore require that firms have the flexibility of moving employees within the firm or even to downsize if necessary. This suggests that not only does the technology adoption process depend on the availability of a skilled workforce, but also on the capacity of firms to adjust their employment levels optimally as necessary.

This paper show empirically that the incentives to adopt new technologies might be stifled in countries with labour market institutions (employment protection legislation) that impose significant hiring and firing restrictions on their firms.

The empirical approach is based on the consideration that, for technological reasons, the ranking of sectors in terms of share of highly skilled workers would be the same across countries but for the existence of differences in institution, policies, etc.

The researchers therefore use US data to rank sectors according to their human capital intensity (measured as the average years of schooling of employees in each sector) because the US labour market is the one with lower levels of regulation and therefore its ranking should capture well the ‘natural’ human capital intensity of a sector.

As it is natural to assume that sectors with a higher share of highly skilled workers in the US are those with a higher propensity to adopt new technologies in each country, one might expect that the effect of employment protection legislation should be relatively larger precisely in human capital intensive sectors.

The empirical work considers about 50 manufacturing and service sectors for the EU-15 countries over the period 1970-2005. The results indicate that the growth rate differential between a sector at the top of the human capital intensity distribution (production of other transport equipment) and a sector at the bottom of the same distribution (tobacco) is about -0.6 percentage point smaller in a country at the top of the firing costs distribution (Greece) with respect to a country at the bottom of the distribution (Austria).

The main consequence of this result is that countries with high firing costs tend to specialise in relatively mature sectors, characterised by low shares of high skilled employees and low rates of adoption of new technologies. This story helps to explain the pattern of development of European countries, which in the past 15 years have been experiencing sluggish growth and are still characterised by a specialisation model largely based on mature and traditional sectors and limited adoption of advanced technologies in the workplace.

The study also finds that the effect of firing restrictions is particularly large more recently and in the case of countries that are near the technology frontier, suggesting that employment legislation did not play a major role during the 1970s and 1980s (when growth could be achieved simply by imitating well established technologies already developed in the US).

Rather, it started to bind about 15-20 years ago, when most EU countries had completed their catching up with the level of US productivity and growth rates had to be achieved through direct innovations and the adoption of recently developed new technologies (like ICT, automated machinery, etc) that are more dependent than before on experimentation, short-term relationships, better selection of workers and a more flexible labour market.

ENDS

‘Human Capital, Employment Protection and Growth in Europe’ by Maurizio Conti (Università di Genova) and Giovanni Sulis (Università di Cagliari)

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Dr Giovanni Sulis

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Tel (mobile): +39 338 4565754

Dr Maurizio Conti

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