Chapter 4: Why Legislation?
A basic question is why legislation is necessary for achieving employment protection. The obvious answer would appear to be that the employee beneﬁts from a lower risk of being ﬁred and possible compensation when dismissed. Firing costs serve to smooth consumption over possible labour market states during the business cycle, such as employment and unemployment, which increases the utility of employees, since they are likely to dislike risk. But this explanation does not answer the fundamental question why legislation is necessary to accomplish this goal. One could imagine that employees and employers by means of voluntary contracts agree on a rule which would similarly protect the employees from being ﬁred. During their most productive phases, employees could pay an ‘insurance premium’ in the form of lower wages to the employer and then be compensated by a higher income when the job is no longer as productive. If the employers’ cost for employment protection, including potential effects on wages and productivity, is less than the utility the protection gives the employee in the form of increased security, one would think that such contracts would arise 67 PSkedinger_04_Finals.indd 67 1/27/2010 3:56:30 PM 68 Employment protection legislation spontaneously and without involvement from the powers of the state. If employment protection legislation on the whole has beneﬁcial consequences, there must be some kind of market failure to explain why it exists in the ﬁrst place. A market failure can arise, for example, as a result of an incomplete...
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