The Cost of Employment Protection Legislation: Evidence from France

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Abstract: We use a sharp discontinuity in the relation between seniority and severance payment in case of unfair dismissal present in the French labor code to identify the dismissal costs induced by employment protection legislations. In France, the employers have to pay at least six months’ salary to the employees in case of unfair dismissal on a permanent job if seniority exceeds two years. We show, relying on data that this hike in severance payment translates into a significant raise in the job separation rate before the two-year threshold and a drop just after this threshold. We provide and structurally estimate a search and matching model consistent with the data which identifies the hike in the dismissal costs at the two-year threshold. Counterfactual exercises show that dismissals costs reduce the average job duration and increase unemployment.