Employment Protection, Technology Choice, and Worker Allocation

We show empirically that high-risk innovative sectors are relatively small in countries with strict employment protection legislation (EPL). To understand the mechanism, we develop a two-sector matching model where firms endogenously choose between safe and risky technology. Simulations with our calibrated model are consistent with the data: Strict EPL discourages choosing the emerging risky technology because it is more costly to shed workers upon receiving a bad productivity draw. This mechanism helps explain the lowdown in productivity in the EU relative to the US since the mid-1990s that often is associated with lagging adoption of information technology in the EU. Keywords: employment protection legislation, exit costs, information and communication technologies, heterogeneous productivity, risky technology, innovation, sectoral allocation.

JEL Codes: J65, O38

Working paper no. 295