Labour Economics | Employment Protection Legislation | Honey Moon Effect after the Removal of EPL

What is Employment Protection Legislation?

Employment Protection Legislation (EPL) is a labour market institution acting on quantities of the demanded labour force. More precisely, EPL is a set of norms and procedures followed in case
of dismissal of workers. EPL makes it more expensive for employers to adjust the number of workers in a firm in response to shocks. Thus, EPL acts as a deterrent protecting jobholders against unexpected dismissals.

In OECD countries, Employment Protection Legislation (EPL) has several dimensions which include the legal “just cause” for individual dismissals (either economic or disciplinary), statutory severance payments, the minimum notice period, various procedural obligations to be fulfilled before the dismissal, additional regulations for collective dismissals, certain hiring restrictions (lengh of probationary period as well as restrictions to the use of fixed contracts and temporary work) etc. All those dimensions form the EPL scheme of the country.

Normally, there exist two main types of Employment Protection Legislation (EPL) which are different from the economic point of view, namely:

• transfer
• tax.

The transfer is represented by severance payments from employers to employees. They can be negotiated and, therefore, incorporated in wage contracts. Economically, the transfer is neutral and does not affect employment and wages.

Another form of EPL is from the economic viewpoint comparable to the notion of tax. That form of EPL cannot be negotiated and represents various legal and procedural costs paid to third parties. Consequently, those costs can be interpreted as deadweight costs (= loss of surplus) from the economic point of view. In form of a tax, EPL affects job creation and destruction, wages and stocks.

In most cases, reforms of Employment Protection Legislation (EPL) concern only certain subsets of population (two-tier reforms), which creates transitory job creation effects known as the honeymoon effect.

Honeymoon Effect after the Removal of Employment Protection Legislation

Honey moon effect after the removal of Employment Protection Legislation

On the pre-reform stage, Employment Protection Legislation (EPL) ensures that the number of workers covered by permanent contracts remains stable in good and bad times throughout the business circle. In the transition period, the number of workers covered by permanent contracts decreases. After the removal of EPL, there is a small number of workers covered by permanent contracts and the number of workers covered by temporary contracts varies with the business circle.

Welfare Effects of Employment Protection Legislation 

Employment Protection Legislation (EPL) exists in most countries nowadays. It may be more or less strong depending on the country's politics. Normally, there is a tendency that enforcement of EPL is connected to the unemployment in the country. In depressed labor markets EPL tends to be stronger.

It is considered that excessive Employment Protection Legislation (EPL) may be harmful, whereas limited EPL may have positive welfare effects. The following general advantages of EPL are quoted:

• for the worker: EPL reduces the labour market risk in form of income fluctuations for workers with permanent contracts and prevents wage underbidding by outsiders (e.g. migrants)
• for the firm: EPL contributes to loyalty, trust and co-operation between employers and employees, induces workers to invest in firm-specific technologies and reduces their resistance to new technologies
• for society: EPL internalises costs of bad management and prevents firms' opportunistic behaviour.

On the other hand, the following disadvantages cannot be denied:

• for the worker: lower probability to find job if the worker is unemployed and high risks for the worker with the temporary contract, in case of strict EPL - mobbing and selectivity on the workplace
• for the firm: loss in profits, moral hazard-productivity.

Finally, Employment Protection Legislation (EPL) is normally coordinated with other institutions such as unemployment benefits. They can partially or fully substitute substitute EPL by providing insurance against unemployment risk.