Labor Courts and Firing Costs: The Labor‐Market Effects of Trial Delays

• Author: Giuseppina Gianfreda,Giovanna Vallanti
• DOI: http://doi.org/10.1111/irel.12250
• Published date: 01 January 2020
• Date: 01 January 2020

Labor Courts and Firing Costs: The Labor-

Market Effects of Trial Delays

GIUSEPPINA GIANFREDA and GIOVANNA VALLANTI*

Employment protection is the result of labor laws as well as of institutional fac-

tors not encompassed in official legislation. Courts’delays in settling labor dis-

putes are among those factors. Using individual data from the Italian Labour

Force Survey (2008–2010) and exploiting the territorial heterogeneity in the dura-

tion of labor trials across Italian regions we investigate the effect of courts’delays

on the composition of employment. We find that labor courts’delays reduce the

employment rate and increase inactivity of specific categories of workers, i.e.,

women, young, and low-skilled individuals; they also reduce the likelihood of

accessing a permanent occupation and increase the incidence of long-term unem-

ployment for the same groups of workers.

There are no fixed times for the administration of justice, or its execu-

tion, in this unaccountable country. (Pictures from Italy, Charles Dick-

ens, 1846)

Introduction

A growing attention has recently been devoted to the economic conse-

quences of courts’inefficiency. In this framework, it is widely recognized that

the influence of the judiciary on the actual enforcement of laws—and hence

on the quality of institutions—goes far beyond the aspects related to the out-

come of trials. By shaping the contractual framework in which firms operate,

JEL codes: J21, J23, J82, K31, K41.

*The authors’affiliations are, respectively, Universit

a della Tuscia, Viterbo, Italy. E-mail: ggianfreda@

unitus.it; Universit

a Luiss Guido Carli, Rome, Italy. E-mail: gvallanti@luiss.it. The authors would like to

thank Francis Kramarz and Giovanni Notaro for their useful comments and suggestions and the seminar

participants at the ESPE meeting in Berlin and AIEL meeting in Rome for useful remarks. They are also

grateful to Valeria Foroni of the Italian Ministry of Justice and Silvia Dini of the Consiglio Superiore della

Magistratura for their help with the courts’data. All errors are the authors’.

INDUSTRIAL RELATIONS, DOI: 10.1111/irel.12250. Vol. 59, No. 1 (January 2020). ©2020 Regents of the

Universit y of Calif ornia. Published by Wiley Periodicals, Inc., 350 Main Street, Malden, MA 02148, USA,

and 9600 Garsington Road, Oxford, OX4 2DQ, UK.

40

the efficiency of the judicial system affects several aspects of firms’decision-

making processes, such as investment and employment decisions and, more

generally, contractual relationships, which ultimately influence aggregate eco-

nomic performance. In this respect, the length of trials per se is one aspect of

the judiciary which may undermine economic development, as also stressed by

the Organization for Economic Co-operation and Development (OECD 2013).

This article contributes to the effects of institutions on economic perfor-

mance by looking at the interaction among institutions empowered with the

settling and the enforcement of rules. We focus on the judiciary, and more

specifically on the interplay between labor courts’delays and employment pro-

tection legislation (EPL) and investigate how and to what extent the speed of

labor trials impacts workers’employment opportunities by affecting dismissal

costs.

Most empirical studies on the impact of dismissal costs on job reallocation

and employment are based on aggregate indexes of EPL, which provide a

measure of the strictness of the legislation on workers’dismissal at the country

level.

1

One important limitation of these aggregate indexes is that they only

take into account formal law provisions and fail to capture the de facto impact

of other institutional factors, which may nonetheless play a significant role in

the implementation and enforcement of job protection. As a result, the actual

cost of dismissal rules can be very different even across countries with similar

employment protection legislation if law provisions are enforced in a com-

pletely different way.

The length of labor trials is a key determinant of the actual amount of firing

costs that firms are confronted with when they make their hiring and firing

decisions. Differently from other judicial outcomes that cannot be immediately

related to EPL, the length of labor trials has a clear interpretation in terms of

firing costs.

2

First, courts’delays directly affect workers’compensation in

cases of unfair dismissals when such a compensation is proportional to the

time elapsing from the firing decision to the court ruling; this happens for

example in most OECD countries (Venn 2009).

3

Second, the prolonged

1

The OECD EPL index is one of the most widely used in the empirical studies on the economic effects

of labor-market regulation (OECD 2004; Venn 2009). Apart from the OECD index, other indicators of the

stringency of labor regulation have been developed. Such indicators, which generally cover a larger set of

countries than the OECD index or a longer period of time, have been constructed by either by the World

Bank or by individual researchers (see for example Belot and Van Ours 2004; Blanchard and Wolfers 2000;

Botero et al. 2004).

2

See for a discussion Fraisse, Kramarz, and Prost (2015).

3

In many countries, when a firing decision is ruled unfair, the employer is required to pay legal

expenses and, on top of that, to compensate the unfairly dismissed employee with the full foregone wages

and social contributions for the length of time between the dismissal and the final judge’s decision.

Labor Courts and Firing Costs /41

uncertainty about the result of the trial—induced by courts’delays—can hin-

der, at least temporarily, the adjustment process of the employment and invest-

ment at firm level with a negative effect on firms’business opportunities and

productivity.

4

This article studies the impact of the length of labor trials as a determinant

of the strictness of EPL on demographic patterns of employment and, ulti-

mately, on the labor-market gap of individuals with different employability

characteristics. We argue that labor courts’delays increase firms’firing costs

and therefore affect workers’employment opportunities by reducing inflows

into unemployment and, at the same time, making it more difficult for job

seekers to enter employment.

5

The overall net impact of dismissal costs induced by labor courts’delays on

aggregate employment is theoretically undetermined because of the negative

effect on both job creation and job destruction; nevertheless, the increase in

firing costs may hamper job opportunities of individuals with different charac-

teristics differently. For example, youths, as new entrants into the labor mar-

ket, and prime-age women with intermittent participation spells, are more

likely to be affected by the reduction in job creation. Moreover, in the pres-

ence of asymmetric information and high firing costs, firms increase the share

of workers hired with temporary contracts in order to reduce the probability of

a "bad" match. This will mostly affect less experienced (typically young) and

less educated workers. In addition, firms tend to hire more from the employed

seekers pool rather than among the unemployed workers, increasing the dura-

tion and persistence of unemployment (Kugler and Saint-Paul 2004). Because

stricter employment protection affects more individuals who already have a

weak position in the labor market, higher dismissal costs due to courts’delays

may exacerbate the labor-market gap among workers with different characteris-

tics.

The analytical framework of our work is close to that of Kahn (2007). How-

ever, his approach, as with most studies on the effect of firing costs on job

flows and employment based on aggregate EPL indexes, does not allow us to

distinguish between EPL provisions and EPL enforcement. Differently, we

4

For instance, Bloom (2009) shows how higher uncertainty causes firms to temporarily pause their

investment and employment decisions.

5

There is a large theoretical and empirical literature showing how firing costs affect firms’employment

decisions and workers’employment opportunities. In a standard search and matching model, the searching

process is costly both for firms and workers. Firing costs protect existing jobs, thus reducing job destruction;

however, they also undermine job creation as firms anticipate costly dismissals. By decreasing both job cre-

ation and job destruction higher firing costs unambiguously reduce job reallocation while the effects on

employment are ambiguous (Hopenhayan and Rogerson 1993; Mortensen and Pissarides 1994; Pissarides

2000). See Skedinger (2011) for a comprehensive survey.

42 / GIUSEPPINA GIANFREDA AND GIOVANNA VALLANTI