A Pure Theory of Job Security and Labour Income Risk

Abstract

Models of labour market equilibrium where forward-looking decisions maximizeboth profits and labour income on a risk-neutral basis offer valuable insights intothe effects of employment protection legislation. Since risk-neutral behaviourin the labour market presumes perfect insurance, however, job securityprovisions plays no useful role in such models. This paper studies a stylizedmodel of dynamic labour market interactions where labour reallocationcosts are partly financed by uninsured workers' consumption flows. In theresulting second-best equilibrium, provisions that shift labour reallocationcosts to risk-neutral employers can increase productive efficiency if theiradministrative dead-weight costs are not too large, and increase workers' welfareas long as employers' firing costs at least partly finance workers' mobility. Copyright The Review of Economic Studies Limited, 2004.

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