LEADING THOUGHTS

It is a classic wedge issue in worker-friendy jurisdictions: do tough labour laws protect the powerless or create inefficiencies by limiting an employer’s ability to negotiate or terminate labour contracts? In the world of public and academic opinion, the latter wins out.

But in a working paper, Viral V. Acharya (London Business School, NYU-Stern, and CEPR), Ramin Baghai-Wadji, and Krishnamurthy V. Subramanian argue that stringent labour laws can actually spur innovation because they make it hard for companies to punish employees for short-term failures.

Using patents and citations as proxies for innovation, they provide empirical evidence that laws governing dismissal of employees motivate firms to pursue value-enhancing innovation.

They find that while the overall effect of stringent labour laws is to dampen economic growth, laws that govern dismissal of employees are an exception: stringent laws governing dismissal actually promote economic growth.

“We know from the tenure-track system for academic appointments that there is a trade-off between promoting innovative research by granting faculty a certain period over which their job is guaranteed and entrenching them for too long,” they write. “This paper showed that this relationship between innovation and ease with which employees can be dismissed by firms exists even in the corporate sector.”

Those who decry the use of stringent labour laws still have plenty of academic evidence to support their cause. Researchers have found, for example, that heavier labour regulations dampen labor market participation, investment, productivity, and output, and increase the likelihood of value-reducing major asset sales.

Labor Laws and Innovation, by Viral V. Acharya, Ramin Baghai-Wadji, and Krishnamurthy V. Subramanian, NYU Working Paper No. FIN-08-034

Email me for a copy of this paper: Alan [at] AlanMorantz.com