The Role of Institutions and Firm Heterogeneity for Labour Market Adjustment

This paper investigates the role of policies and institutions for aggregate labour market dynamics duringthe global financial crisis using firm-level data. The use of firm-level data is important if firms areheterogeneous in their labour input adjustment technologies. In this case, cross-country differences inaggregate labour market dynamics may not just stem from cross-country differences in average labourinput technologies - here assumed to be largely due to differences in institutional settings -, but also fromdifferences in the distribution of shocks across firms within countries and the composition of firms acrosscountries. The contribution of this paper is threefold. First, the paper provides comparable estimates of thelabour input adjustment behaviour of firms in response to output shocks across countries, industries andfirm-size groups. Second, it makes use of decomposition methods to get a first indication of the importanceof cross-country differences in adjustment technologies, the distribution of shocks across firms and thecomposition of firms across countries. We find that differences in the adjustment behaviour of firmsaccount for about 40% of the cross-country variation in aggregate employment growth during the globalfinancial crisis. We interpret this as prima facie evidence that differences in institutional settings accountedfor a substantial part of the variation in aggregate employment growth during the crisis. Third, we find thatemployment-protection provisions with respect to regular workers reduce the output elasticity ofemployment, but increase the output elasticity of earnings per worker. Thus, employment protection tendsto shift the burden of adjustment from the extensive to the intensive margin. However, the quantitativeimpact of employment protection for explaining the variation in aggregate labour dynamics during theglobal financial crisis is relatively small.