Access to credit and employment protection legislation

Might access to credit have anything to do with support for employment protection legislation (EPL)? Felipe Balmaceda and Ronald Fischer propose a connection. Workers in firms with easy access to credit EPL. Workers in firms with shaky access to credit oppose EPL.

Their theoretical model deserves a more detailed treatment than I can offer here, but I’ll do my best to summarize briefly. Their paper is titled “Economic Performance, Creditor Protection and Labor Inflexibility” (ungated copy available here).

Consider the following two scenarios:

Scenario 1: The firm cannot obtain credit easily, maybe because the liquidation value in case of default is low. A worker in this firm will oppose EPL. The logic is simple. The increased dismissal costs mean the firm simply cannot get credit, since workers get paid before creditors get paid in case of bankruptcy. Creditors anticipate this problem and simply refuse to lend. No credit means no job for the worker.

Scenario 2: The firm can obtain credit easily, maybe because the liquidation value of the firm in case of default is high. A worker in this firm will support EPL. Again the logic is simple. The firm can get credit with or without EPL, so the worker’s job is not on the line right now. If the firm gets into trouble later, however, the worker gets a fat severance payment.

The issue of employment protection is a sensitive one. I think it helps the policy debate when we think carefully about sources of support for EPL. I hope other careful thinkers will also take a close look at this topic.