World Bank Employment Policy Primer December 2002 No. 1 Employment Regulation Rules for Hiring and Termination * Introduction In the end, policy-makers must grapple with two Employment protection ­ the set of rules governing overarching issues: How much protection will be pro- hiring and terminating employees ­ is a key feature of vided to workers against the uncertainties of job loss? any country's labor market. What types of contracts will What is the balance between providing this protection be permitted between employers and employees? Under inside the firm through job security rules or outside the what conditions can the relationship be terminated? firm through social protection instruments such as state What are the requirements for providing advance unemployment benefits and re-employment programs? notice? What are the obligations of the employer regard- ing severance or termination payments? These are Background important questions for policy-makers in addressing the In traditional and informal economies, employers trade-offs between labor market flexibility and the eco- and workers are engaged on an "at will" basis ­ in nomic security of employed workers. other words, as long as both want to be party to the Employment protection practices in any country are relationship. In more formal economies, explicit regu- determined by a mix of cultural norms, collective bar- lations determine what contractual arrangements are gaining, and legislation. This primer note focuses on the acceptable between employers and workers and what statutory regulations affecting employment protection. It is acceptable regarding the termination of those provides a basic overview of the policy options and a arrangements. These regulations are usually stipulated summary of what is known about their impacts on work- through a Labor Code or another piece of employ- ers and on the labor market. It also addresses the institu- ment legislation. Employment protection arrange- tional and political aspects of employment protection. ments can also be included in collective agreements, in The note is based on international experience, both enterprise personnel policies, or in individual con- in terms of hiring and termination regulations and evi- tracts. However, these generally cannot undercut any dence on their labor market impacts.1 statutory regulations. Employment protection legislation ­ also referred to as job security rules ­ can cover a long list of items: 1The primary background piece for this note is Betcherman, Luin- what kinds of contracts are permitted; stra, and Ogawa (2001). any special rules favoring certain groups in hiring; *This note has been prepared by Gordon Betcherman and edited by Tim Whitehead. The World Bank Employment Policy Primer aims to provide a comprehensive, up-to-date resource on labor market policy issues. The series includes two products: short notes, such as this one, with concise summaries of best practice on various topics and longer papers with new research results or assessments of the literature and recent experience. Primer papers and notes are available on the labor markets website at or by contacting the Social Protection Advisory Service at (202) 458-5267 or by email at . E m p l o y m e n t R e g u l a t i o n BOX 1: THE EMPLOYMENT PROTECTION CONTINUUM RIGID OR FLEXIBLE OR PROTECTIVE UNREGULATED Fixed-term contracting restricted Unrestricted fixed-term contracting Temporary agency work (labor dispatch) restricted Unrestricted temporary agency work Hiring standards No hiring standards Employer dismissal rights restricted Unrestricted dismissal rights Substantial severance and advance notice required No severance or notice required Substantial administrative requirements for layoffs Simple administrative procedures occupational standards; protection policies. One perspective sees restrictions on the conditions under which workers can be ter- non-permanent hiring and on employer dismissal rights minated; as providing important social protection for workers. An requirements for severance and advance notice of opposing view emphasizes the fact that these regulations termination; raise the cost of labor and thus discourage job creation redundancy procedures; and and favor more privileged "insiders" (Freeman 1993). special rules for mass layoffs. These different views very often clash when countries are considering reforms to their labor laws. Accordingly, Economists and some policy-makers often character- the political economy aspects of employment protection ize employment protection arrangements along a "rigidi- cannot be ignored. ty/flexibility" continuum. However, those emphasizing In the end, good labor market policy must get the protective nature of job security rules are more likely beyond these ideological positions. How the labor mar- to consider the continuum as "protective/deregulated." ket is regulated can have potentially significant effects on There is considerable variation in terms of where the rates of job creation and destruction; levels of countries fit on the spectrum illustrated in Box 1. An employment and unemployment; productivity, wages, important determinant is the national legal and cultural and profits; and the degree of social protection and jus- tradition. In countries with Anglo-Saxon heritage where tice afforded workers. The magnitude of these effects common law principles prevail, statutory regulation depends on the degree of protection provided, the level plays a smaller role in directly providing employment of compliance, and the reach of the formal sector. Later protection than it does in countries with civil law prin- in this note, we summarize the findings of empirical ciples (e.g., French or Spanish tradition) or in countries studies into these effects. that have or recently had planned economies. Develop- ing countries often follow the traditions of the countries Employment protection regulations that colonized them. However, even where very strong job security provisions exist "on paper," their application Hiring "on the ground" may be limited because of weak The most important issue on the hiring side con- enforcement and large informal sectors. cerns the rules for non-standard workers ­ i.e., workers Employment protection rules enhance job security who are contracted for a temporary or fixed duration. for employees in two ways: by restricting the ability of Where these forms of employment are restricted, employers to hire workers on an explicitly non-perma- employers are legally obliged to offer workers indetermi- nent basis and/or by restricting employer freedom to nate contracts with the statutory job security (and atten- terminate workers. The general idea, in either case, is to dant costs) these contracts afford. On the other hand, make dismissal costly to the employer. employers have complete flexibility to terminate fixed- Controversies surround sharp differences of opin- term (at term end) or temporary agency employees. ion about the costs and benefits of these employment Restrictions on these forms of contracts usually pertain 2 E m p l o y m e n t R e g u l a t i o n Table 1: Legal Arrangements for Fixed-Term Contracts and Temporary Agency Work in Selected Countries Fixed-Term Contracts Temporary Agency Work Ethiopia Permitted only in the following cases: Licenses for private employment agencies are · specified piece work; required from regional or national authorities, · temporary replacement of absent worker; depending on scope of activities. · urgent work to prevent damage or disaster to life or property; · work relating to the industry but performed at irregular intervals; · seasonal work. Chile Maximum duration one year after which the contract becomes one of indeterminate duration. Czech Republic Not allowed for: · graduates of university-level schools or No restriction specialist apprentice schools hired for work that corresponds to their qualifications; · adolescents; · employees under collective bargaining agreement; or disabled persons Spain Permitted for various reasons (e.g., specific Allowed for justifiable cases projects; temporary replacements; training contracts; production eventualities; special categories of workers; long-term unemployed) Japan · < 1 year duration without restriction Restricted to specific occupations · up to 3 years for particular types of workers Germany · Widely possible without justification Generally approved except for construction · Maximum number of 4 contracts/24 months (no limits in justified cases) United States No restrictions No restrictions Source: Betcherman, Luinstra, and Ogawa (2001) to the types of work (e.g., occupations), the number of Termination renewals, and the maximum duration allowed. The key policy issue here concerns how difficult Table 1 summarizes the statutory rules in these areas and/or costly it is for employers to terminate indetermi- for a set of countries selected to illustrate the range of nate employees for economic reasons.3 Restrictions can approaches and to offer some geographical variation.2 take various forms including: what is considered to be a The table demonstrates the considerable variation that justifiable reason for termination; severance obligations exists and approximately orders the countries from most upon termination; advance notice requirements; and to least protective. During the 1990s, at least in devel- necessary administrative procedures for laying off work- oped countries, there generally was a loosening of restrictions on non-standard contracting. 3"Economic" reasons include business-related causes for termina- 2 Selected labor legislation provisions, covering employment protec- tion (e.g., shrinking markets, increasing competitiveness, etc.). This tion as well as other aspects of labor regulation, have been compiled class of terminations stand in contrast to dismissals for "non-eco- for 17 countries in the annex of Betcherman, Luinstra, and Ogawa nomic" reasons such as discrimination, union organizing, or job (2001). HOT-LINK. performance. 3 E m p l o y m e n t R e g u l a t i o n Table 2: Legal Arrangements for Termination, Selected Countries Justifiable reasons for economic dismissal Severance requirements Advance notice required Chile Economic reasons include · 30 days wage per year of · 30 days, dismissal without cause modernization activities, service if dismissed for or economic reason; reduced productivity, changes economic reasons · With cause, written justification in market, etc. (upper limit = 330 days). required for worker and labor · 20% premium if dismissal inspectorate within 3 days of is unfair termination; Ethiopia · Decline in demand for the · 30 days wages for first year of · 1 month if employed < 1 year; products or services of the service. · 2 months if employed > 1 year; employer; · 1/3 monthly salary for every · plus 1 month if reduction of · Alteration in work methods or additional year of service workforce new technology to increase (12 month limit) productivity. · Additional 60 days pay if mass layoff Spain Economic redundancy 20 days' wages for each year of · 30 days notice service (up to 12 years) · for mass layoffs, consultation required for 15/30 days in firms with <50/>50 employees Czech Republic · Employer shuts down or 2 months pay, in case of shut · 3 months if employer shuts down relocates; down, relocation, transfer of or relocates and for redundancy; · Employer ceases to exist or employer, or redundancy. · 2 months for other reasons. merger or acquisition · New technology or reorganiza- tion to increase efficiency Germany Compelling business or No legal entitlement but often · Progressive increase based on years operational needs included in collective agreements of service (from 2 weeks to 7 months for >20 years of service) · 1 month delay required after public notice for mass layoffs Japan · Rational restructuring reason No legal entitlement but most · 30 days notice or unavoidable redundancy large enterprises have voluntary · Notification also to Public (court precedence, not law) plan Employment Security Office in mass · Reasonable selection criteria layoff (>30 workers) United States No restriction (except in public No legal requirement but · No regulation for individual sector)a voluntary or negotiated dismissal policies exist · 60 days notice for mass layoffs a. In reality, U.S. employers do face some constraints on their dismissal rights because of court decisions and collective agreement provisions. Source: Betcherman, Luinstra, and Ogawa (2001). ers (including union approval). There may also be spe- some have strengthened protections, others have eased cial requirements in the case of mass layoffs. them, but in most cases arrangements have remained Table 2 provides examples of statutory arrange- relatively stable. In some developing countries ­ includ- ments regarding what are legally acceptable reasons for ing many in Latin America ­ job security rules have been economic dismissals; what severance requirements exist; scaled back. and what advance notice is required for the same set of countries included in Table 1. Again countries are Labor market impacts of employment approximately ordered from most to least protective. protection regulations During the past decade or so, there has been no clear These regulations on hiring and termination are trend in regulating dismissals in developed countries: often hotly debated not only because they define the job 4 E m p l o y m e n t R e g u l a t i o n Table 3: Summary of Impacts of Employment Protection Regulations Impacts of strict limitations regarding: Fixed-term and temporary Terminating indeterminate agency work employees for business reasons Employment Somewhat lower Somewhat lower Labor force participation N/a Somewhat lower Unemployment Insignificant Insignificant Unemployment duration Longer Longer Non-standard employment N/a Probably higher Informal employment Higher Higher Job creation Lower Lower Job destruction Lower Lower Labor turnover N/a Lower Job tenure N/a Longer Groups benefiting Prime-age males, skilled Groups losing Women, youth Women, youth, unskilled Source: Synthesis based on Betcherman, Luinstra, and Ogawa (2001). security of employees but because they have potentially more empirical research is required in developing coun- important implications for economic and labor market tries in order to see whether the impacts of job security performance. Unfortunately, these aggregate effects too rules are affected by large informal sectors, weak com- often are not adequately considered when policy-makers pliance, and other factors that distinguish labor markets are considering labor market reforms. Empirical in developing countries from those in developed research shows that employment protection arrange- economies. ments can have impacts on employment and labor mar- The impacts on employment and unemployment ket dynamics (e.g., turnover, job creation/destruction, levels are modest and, in the case of unemployment, response to shocks, etc.). They also can affect the forms often statistically insignificant. This suggests that the of employment, the labor market situation of different negative aggregate effect of these rules is less than many types of workers, and the size of the informal sector.4 economists assume. However, the empirical findings are Table 3 summarizes the research findings. The much stronger for the dynamic effects ­ on labor largest body of evidence concerns the experience of turnover and job tenure, job creation and destruction, developed countries. There has been less empirical and unemployment duration ­ and on the types of jobs analysis in developing and transition countries.5 How- created. More flexible employment arrangements are ever, some recent studies have assessed the labor market likely to facilitate adjustment to macroeconomic impacts of employment protection regulations in Latin shocks. Overall, rules to protect job security increase the America (Heckman and Pages 2000) and Eastern Europe number of stable jobs but at the price of more long- (Riboud et al. 2002). At any rate, it is clear that much term unemployment and non-participation in the labor force and less opportunity for regular employment in the formal sector. This increases the vulnerability of 4There are various methodological and data issues that researchers certain groups of workers including women and youth, must confront in this field. For a summary, see Betcherman, Luin- and the unskilled or poorly educated who are less likely stra, and Ogawa (2001) -- HOTLINK. 5Exceptions are Freeman (1993) and Lindauer (1999). to get these jobs. Many of these workers, then, will be 5 E m p l o y m e n t R e g u l a t i o n relegated to being either out of the labor force or in the opposed to binding decisions made by government informal sector. This has to be weighed against weaker inspectors, arbitrators, or judges. While these approach- job protection rules that do not discourage formal sec- es can reduce the number of complaints that cannot be tor job creation but provide a lower level of protection resolved by the parties, there is still a need for judicial in these jobs. review and a court option. Enforcement and dispute resolution International conventions Reform of employment protection laws should not Drafters of labor legislation should consider rele- ignore enforcement and dispute resolution. In many vant international conventions. These are adopted at the developing and transition countries, these features are International Labour Organisation (ILO), the special- weak and, as a result, hamper the effectiveness of labor ized United Nations agency responsible for promoting market regulations. labor rights and decent working conditions. The ILO has Enforcement is a longstanding concern in most a tripartite structure in which representatives of workers developing countries. Informal sectors, largely outside and employers participate on an equal basis with gov- the reach of inspectors, are large ­ often representing a ernment officials. Once the tripartite assembly adopts a significant share, if not the majority, of the labor force. Convention, national governments (usually legislatures) Developing countries typically do not allocate a lot of have the option of ratifying the Convention. If they resources to enforce labor market regulations, even to choose to ratify it, national governments are obliged to police the most visible employers (e.g., the public sector). incorporate the principles of the Convention into For this reason, it is important for the regulatory frame- national law and practice and to submit periodic reports work to be realistic so that self-compliance will be high to the ILO. Conventions are designed to be universal in and the enforcement challenge moderated. That does not that all states should be able to implement them regard- mean that labor codes should have no protections for less of their level of economic development or their par- employees but rather that they should accord with good ticular social, political, or economic system. business practices in the specific national context. Termination of Employment Convention (No. 158) Many types of labor regulations are enforced obliges ratifying states to meet various standards for dis- through inspections, as well as by responding to com- missal, including termination for economic reasons: plaints. Both approaches apply, for example, to occupa- tional health and safety.6 The hiring and termination In cases of termination for economic/structural rules that are the subject of this note are enforced reasons, employers must (a) notify workers rep- through complaint procedures. For example, where resentatives; (b) allow for consultation with employees believe that employers have violated hiring or workers on measures to limit layoffs, mitigate dismissal obligations, efficient and fair dispute-resolu- impacts, retrain workers, and find alternative tion procedures are required. This can happen in various employment; and (c) notify government author- ways: labor/management enterprise committees; gov- ities of planned terminations; ernment arbitrators; and labor or civil courts. There has Notice of termination or compensation in lieu not been rigorous evaluation of the effectiveness of these thereof must be given "in a reasonable period," approaches. However, a good rule of thumb is to resolve except in cases of serious misconduct; as many disputes as possible through pre-judicial proce- Terminated workers are entitled to "(a) severance dures. In fact, many developed countries are relying allowance or other separation benefits, the increasingly on alternative dispute resolution which amount of which shall be based inter alia on emphasizes fact-finding, mediation, and conciliation as length of service and the level of wages, and paid directly by the employer or by a fund constituted by employers' contributions; or (b) benefits from 6Many developed countries are increasingly experimenting with unemployment insurance or assistance or other enterprise "self-compliance" plans that are endorsed by govern- forms of social security, such as old-age or inva- ments. For a discussion, see Betcherman, Luinstra, and Ogawa lidity benefits, under the normal conditions to (2001). HOTLINK. 6 E m p l o y m e n t R e g u l a t i o n which such benefits are subject; or (c) a combi- lation can affect labor market performance and benefit nation of such allowance and benefits;" and certain classes of workers while reducing opportunities Casual, fixed-term, and probationary workers can for others. be excluded from these provisions. Countries that are considering reforms to employ- ment protection regulations must address various issues. Private Employment Agencies Convention (No. 181) First are the likely labor market impacts of different obliges ratifying states to provide certain protections for regulatory options. To the extent that the findings from workers employed by private employment agencies and developed countries can be generalized to developing establishes standards for regulating these agencies: countries, we know that stricter employment protection regulations will indeed make jobs more secure but with Agencies should not deny freedom of association apparent costs: more long-term unemployment and less and collective bargaining rights; they should not opportunity for regular employment in the formal sec- abuse child or migrant workers and they should tor. This latter cost is likely to disproportionately affect adopt equal opportunity and anti-discrimination vulnerable groups of workers including women and practices; youth, and the unskilled or poorly educated. However, Agencies should not charge fees of workers country characteristics such as the structure of the econ- (except with government permission); omy, the size of the informal sector, and enforcement States should ensure that temporary agency effort can affect what the labor market impacts will be. workers have adequate protection in terms of Second, political economy is a key aspect of labor rights, conditions and work (e.g., access to train- market regulation. There are always winners and losers ing, maternity leave, minimum wages, etc.); when labor market regulations are reformed and, States can restrict the operation of temporary because the employment impacts hit especially close to employment agencies in specific sectors; and home, changes will be hotly contested. When policy- Certain types of temporary agency work can be makers are considering reform options, they must com- exempted from the standards established in the municate the aggregate benefits clearly; they must Convention. understand who will benefit and who will not; and they may have to compensate the losers. Again, governments are not obliged to ratify these Third, policy-makers need to consider job security conventions ­ they represent the ILO members' agree- regulations in conjunction with other policy options that ment on appropriate standards. However, once a gov- provide protection for workers ­ in particular, the collec- ernment has ratified a convention, it is obliged to imple- tive bargaining framework and programs for unem- ment it. The ILO receives regular reports on the ployed workers. Where collective bargaining is well implementation of ratified conventions but does not developed and has a wide reach, appropriate job security have genuine enforceability powers. arrangements can be negotiated between employers and workers (with labor law providing a basic minimum). Conclusion Similarly, unemployment benefits and effective active There are valid reasons why countries want to labor market programs can help workers manage the ensure that there is some job security provided for work- risks of unemployment and, as such, can be substitutes ers and that labor markets are more than just "spot" for strong employment protection regulation. markets. In formal labor markets, the major policy lever Finally, policy-makers must recognize that labor for providing job security is through regulations that regulation is only one part of the broader economic pol- restrict short-term contracting and make it difficult or icy framework. Its interaction with the regulation of costly for employers to terminate regular employees for product markets, macroeconomic policy, and the busi- economic or business-related reasons. This is a complex ness investment climate will determine overall labor and controversial policy issue because job security legis- market performance. 7 E m p l o y m e n t R e g u l a t i o n Annotated bibliography OECD (1999). Employment Outlook. Paris. LINK. Betcherman, Luinstra, and Ogawa (2001)."Labor Market Reg- Survey of employment protection legislation (EPL) in ulation: International Experience in Promoting Employ- OECD countries and changes over the last decade. Evalu- ment and Social Protection." Social Protection Discussion ates the relationship between strictness of EPL and labor Paper No. 0128. World Bank. Washington, DC. market performance. Finds little relationship to overall Background paper for this primer. Expands on topics dis- unemployment. Finds that stricter EPL may be associated cussed here, including collective bargaining, enforce- with the following: increasing employment levels of ment, and dispute resolution. LINK prime-age males; lower employment levels for women and youth; expansion of self-employment; lower job turnover; Freeman, R.B. (1993)."Labor Market Institutions and Policies: more stable jobs; and longer spells of unemployment. Help or Hindrance to Economic Adjustment?"Proceedings of the World Bank Annual Conference on Development Eco- Riboud, M, Sánchez-Páramo, C., Silva-Jáuregui, C. (2002). nomics, 1992. Supplement to the World Bank Economic "Does Eurosclerosis Matter? Institutional Reform and Review and the World Bank Research Observer. Labor Market Performance in Central and Eastern Euro- Compares the "distortionist" (World Bank) versus "inter- pean Countries in the 1990s." Social Protection Discus- ventionist" (International Labor Organization) views of sion Paper No. 0202. World Bank. Washington, DC. LINK labor market regulation. Concludes that both overstate Evaluates the labor market institutions of EU accession their claims. Efficiency losses are not as major as alleged countries, compares them to those of Western European by the former view, but neither are the social gains of and other OECD countries, and discusses the impact of consultation as large as is maintained by the latter view. macro and structural reform on the labor market com- Proposes new model of labor market policies and inter- pared to institutional changes. Finds that while econom- ventions to support economic reform. ic reform had the most impact on labor market out- comes, relatively inflexible labor market institutions Heckman, J.J. and C. Pagés (2000). "The Cost of Job Security contributed to low employment creation, a rising propor- Regulation: Evidence from Latin American Labor Mar- tion of long-term unemployed, specific patterns of labor- kets." National Bureau of Economic Research. Working force participation and growth in the informal economy. Paper No. 7773. Cambridge, MA. LINK Documents high job security provisions in Latin Ameri- can labor regulation. Shows substantial impact on level (lower) and distribution of employment (more unequal). Lindauer, David L. (1999) "Labor Market Reforms and the Poor." Background paper for the World Development Report 2000/1. World Bank. LINK One of the few survey papers that considers labor market regulation with the context of developing countries and poverty reduction. Concludes that regulatory reforms are likely to only make a modest difference in job creation. 8