Abstract

In this paper we present a theoretical model in which employment protection legislation (EPL) evolves over time and space as labour market conditions change. The basic hypothesis around which the model is built is that when it is easy for workers to find a new job, the strictness of EPL is smaller in comparison to the case in which finding a new job requires a long period of time. This is because when the exit rate from unemployment is high, workers will oppose a smaller resistance to dismissal, thereby reducing the layoff cost for the firm. To simplify the analysis and to capture a central characteristic of the European labour markets, we also suppose that wages are fully rigid, being set in advance by unions and employers. Our main result is that the so-called "European model", where labour market institutions such as EPL heavily affect the decisions of the single agent, does not necessarily imply a lower level of efficiency when compared with the more flexible "Anglo-Saxon model", not only from the point of view of the dynamic analysis but also with regard to the long run steady state.