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Unemployed finally get chance to work

June 16, 2005

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More firings could be good news for the long-term jobless,
writes Andrew Leigh and Justin Wolfers.

AFTER a season of Big Brother ("you're evicted"), The Amazing
Race ("you're eliminated") and The Apprentice ("you're fired"), it is
no wonder that unfair dismissals are back on the political agenda.

Yet the truth is that businesses don't have things so bad: Australia has the
sixth-weakest employment protection of 28 OECD countries. And just like those
reality shows, these reforms are more about ratings than substance. At most,
exempting firms with fewer than 100 employees will shift one in seven workers
outside the scope of the unfair dismissal regime.

How will the changes affect the unemployment rate? So far, two opposing
arguments have been mounted. From the union movement, we have heard that the
changes will make it easier to fire workers. More firing, more unemployment.

On the flip side, employer groups and the Federal Government have argued that
the changes will make firms more likely to hire workers. More hiring, less
unemployment.

Economic theory tells us both sides are right, so we need to look to
empirical studies to see how these competing effects balance out. Despite the
Prime Minister's best misrepresentations to the contrary, the most careful
cross-country studies have found little evidence of a robust relationship
between employment protection and the unemployment rate.

While his supporters point out that high employment protection in Europe may
be a cause of high levels of unemployment, opponents note that Europe had even
higher employment protection and substantially lower unemployment in the
1960s.

The closest reform that we can think of was a 2004 German law that exempted
some small businesses from employment protection laws.

Afterwards, a careful study by Thomas Bauer, Stefan Bender and Holger Bonin
found that this law had essentially no effect on the German labour market. If
John Howard thinks his unfair dismissals reforms will bring the headline
unemployment rate down from 5.1 per cent to 4 per cent, we should bring in
Darryl Kerrigan to tell him he's dreaming.

Yet, while the unfair dismissals reforms probably won't affect the overall
unemployment rate, they are likely to have two positive effects. Oddly, both
have been ignored in the Australian debate.

First, less employment protection will mean more hiring and more firing and,
hence, more job churning.

For those with jobs, this may not sound like a particularly enticing
prospect. But for the unemployed, it matters a lot. The flip side of greater
certainty that those with jobs will remain employed is greater certainty that
the unemployed will remain unemployed.

With decreased hiring, those without work are likely to remain jobless for
longer. Indeed, cross-country evidence shows a robust relationship between
employment protection and higher long-term unemployment. Making hiring and
firing easier will help spread the burden of unemployment across the
workforce.

Since we know that the worst results of unemployment come from the
de-skilling and depressing effect of prolonged joblessness, this provides a
powerful equity argument for reform. Moreover, this also yields an important
efficiency argument: if adverse macroeconomic shocks cause long-term
unemployment to rise, it can take decades for the economy to recover.

Indeed, it took a decade for Australia's unemployment rate to return to its
level before the Reserve Bank-induced recession in 1990-91.

Research by Olivier Blanchard and Justin Wolfers finds that countries with
less strict firing laws recover more robustly following adverse economic shocks.
Those who benefit most from a rapid recovery are the most disadvantaged in
Australian society.

The equity and efficiency arguments in favour of relaxing Australia's unfair
dismissals regime have received little play in the mainstream press.

Perhaps this is because both are more nuanced than the simplistic mantra that
making dismissals easier will create or destroy jobs.

But we also think there is another reason why these two arguments have not
been made: the long-term unemployed are not represented in the political
debate.

This is a pity.

Unfair dismissals reforms probably won't bring down the jobless rate, but
they may make being unemployed a whole lot less painful.

Dr Andrew Leigh, Dr Justin Wolfers are economists at the Australian
National University, the University of Pennsylvania respectively.

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