Wrongful Discharge Law Can Enhance Employment Among Highly Skilled Workers

01 Jun 2007

Greater protection against dismissal can increase employment for highly skilled workers, according to new research by Professors Bentley MacLeod and Voraprapa Nachavachara, published in the June 2007 issue of the Economic Journal. In contrast, for low skilled workers and those in more competitive labour markets, their study confirms that more restrictive labour law reduces employment.

The appropriate degree of government intervention in private contractual relationships – particularly in employment law – remains a fraught public policy issue. This research finds that for skilled workers, recent changes in US labour law that increases the standards for dismissal may in some cases also increase employment.

The result may help to explain why most countries have some form of labour law regulation that restricts an employer''s ability to hire and fire a worker at will, even though much economic policy advice – such as the 1994 OECD jobs study – recommends reducing employment protection.

The authors explain these results by observing that the source of more restrictive labour law in the United States originates with court cases where employers have behaved in bad faith, and in some cases dishonestly. In a highly competitive labour markets where employees can easily find other work, then the market can discipline these employers because workers can at low cost shun these employers.

The situation is quite different for highly skilled employees, particularly those that have made large investments in the firm, either by learning skills that only their employer finds useful (for example, the telephone operators of the past) or who have moved to areas where there are few alternative job opportunities.

In these cases the cost of changing employers is significant, and hence these employees risk being held up by their employer in the future. The employer may use its superior bargaining position in the future to reduce income or unfairly dismiss the worker.

In these cases, efficient employment entails the use of a long-term employment contract backed by the force of law. Such contracts can increase worker productivity, and hence total employment is likely to be higher when such long-term contracts are possible.

US courts permit firms to choose contracts that provide no employment protection, and hence increased employment protection does not preclude the use of employment-at-will. But the law does not allow firms to promise long-term employment, either informally or in their employee handbook, and then later renege on these promises.

The authors use the Current Population Survey to explore the effect of changes in US labour law at the state level from 1983 to 1994 on state level employment levels. The United States is an excellent laboratory to study the impact of labour law because they are set at the state level.

Given that US states are relatively similar, then it is possible to use variations in state law to explore the causal impact of the law on employment. Accordingly, the authors find that the good faith exception to employment-at-will results in less employment for low skilled workers (a result that is consistent with earlier studies) but greater employment for highly skilled workers.

''Can Wrongful Discharge Law Enhance Employment?'' by Bentley MacLeod and Voraprapa Nachavachara is published in the June 2007 issue of the Economic Journal.

Bentley MacLeod

Columbia University | bentley.macleod@columbia.edu

Voraprapa Nachavachara

University of Southern California