A hysteresis model-based indicator for employment adjustment rigidity

The accurate measurement of employment adjustment rigidity is essential to assist labour market reforms that are currently viewed as a key to economic recovery of the Euro area peripheral countries. Usually, labour market rigidity is assessed through the researcher's reading of the legislation or other similar measures. In this work we propose a new indicator for labour market rigidity computed from data on the adjustment of employment and hours per worker. We model employment dynamics with a linear play model of hysteresis, which is adequate in the presence of non-convex employment adjustment costs, and derive a switching regression model with a time-varying splitting factor estimated on monthly data for 15 OECD countries and 14 years (1995–2008). The numerical results provide an employment rigidity ranking of countries that is neither vulnerable to enforcement issues nor to subjective interpretations of the law. With this new and practical procedure, a single parameter summarises different labour markets according to their readiness of employment adjustment. Moreover, it is easily computed and updated from publicly available data. Comparing the new proposed ranking with others, used as a benchmark for the rigidity of employment protection legislation, we find a positive and significant association between the common employment protection legislation indices and our employment adjustment indicator. The rank correlations are especially high with the OECD indicators. Yet, our findings indicate that the OECD rankings seem to overstate employment rigidity at the ranking top positions and understate it at the bottom.