What is the effect of employment protection legislation (EPL) on
labor market outcomes? Conventional wisdom suggests that
differences in labor market conditions can be explained by
differences in EPL, so that different performances of U.S. and
European labor markets depend on different degree of strictness of
EPL. In this book we introduce the alternative view that the
strictness of EPL depends on the labor market conditions, and
investigate the consequences of this "reverse" causality nexus on
labor market performance. The intuition is straightforward: when
the level of economic activity is low, the costs of employment
protection are higher, and EPL appears stricter than in
economically healthier conditions. A relevant implication of this
result is that labor market performance is the variable that moves
the economic system towards a higher or lower level of rigidity in
terms of job protection. Therefore, there is a reverse causality
between EPL and labor market outcomes: it is not labor market
rigidities that cause poor labor market performance, but rather, it
is labor market conditions that cause the degree of rigidities of
the labor market.
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