Journal of Law, Finance, and Accounting > Vol 5 > Issue 2

Basic Employment Protection, Bargaining Power, and Economic Outcomes

Stijn Claessens, Bank for International Settlements (BIS), Switzerland and 2entre for Economic Policy Research (CEPR), UK, , Kenichi Ueda, The University of Tokyo and Tokyo Center for Economic Research (TCER), Japan and Centre for Economic Policy Research (CEPR), UK,
Suggested Citation
Stijn Claessens and Kenichi Ueda (2020), "Basic Employment Protection, Bargaining Power, and Economic Outcomes", Journal of Law, Finance, and Accounting: Vol. 5: No. 2, pp 179-229.

Publication Date: 08 Sep 2020
© 2020 S. Claessens and K. Ueda
Corporate finance,  Labor economics,  Law and economics
JEL Codes: O43, O16, J08, J83, G28, G33, G34
Institutions and growthemployment protectionbank monopolytime inconsistency


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In this article:
1. Introduction 
2. A Simple Theoretical Model 
3. Data and Facts 
4. Empirical Analysis 
5. Conclusion 


We propose a simple theory suggesting that basic employment protection can improve economy-wide welfare as it mitigates a time inconsistency problem that makes a firm’s promise to workers less credible. By tilting the bargaining power in renegotiations on contract terms toward workers, basic employment protection can incentivize workers to invest in firm-specific human capital and allow firms to keep operating. This contrasts to the case of rigid labor protection, which forces firms to go bankrupt too often with economic costs. We test for the effects using a quasi-natural experiment: US workers gained basic protections between the early-1970s and the mid-1990s, but in years varying by state. We find employment protection to benefit the growth of knowledge-intensive industries. We corroborate another prediction that stronger bargaining powers of workers vis-à-vis other stakeholders since contemporaneous bank branch deregulations (i.e., reduction in banks’ monopoly powers) also benefit knowledge-intensive industries. Although labor and financial reforms are rarely jointly investigated, we confirm that the direct positive effect of basic employment protection prevails when correcting for (changes in) creditors’ powers and vice versa. Since the findings do not maintain for R&D-intensive industries, we interpret the firm-specific human capital in our theory broadly, as for white-collar jobs.