This paper explores the short-term employment effect of deregulating job protection for
regular workers and how it varies with prevailing business cycle conditions. We apply a local
projection method to a newly constructed “narrative” dataset of major regular job protection
reforms covering 26 advanced economies over the past four decades. The analysis relies on
country-sector-level data, using as an identifying assumption the fact that stringent dismissal
regulations are more binding in sectors that are characterized by a higher “natural” propensity
to regularly adjust their workforce. We find that the responses of sectoral employment to large
job protection deregulation shocks depend crucially on the state of the economy at the time
of reform——they are positive in an expansion, but become negative in a recession. These
findings are consistent with theory, and are robust to a broad range of robustness checks
including an Instrumental Variable approach using political economy drivers of reforms as
instruments. Our results provide a case for undertaking job protection reform in good times,
or for designing it in ways that enhance its short-term impact.
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