Dismissal conflicts and unemployment

Abstract

Firing costs are often blamed for unemployment. In this paper, we investigate this widespread belief theoretically. Firing costs are introduced in an efficiency wage model to capture their effects on employment through wages. In addition, dismissal conflicts are modelled explicitly and their cost is derived. These two elements are included and linked. Modelling firing costs in a context where worker effort is not perfectly observable implies that a double moral hazard problem could arise. Whenever firms face a redundancy, they tend to use disciplinary dismissals in order to avoid paying firing costs. Similarly, workers will then tend to deny any disciplinary case to get a compensation. Our claim in this paper is that the resolution of this problem by a third party will be imperfect given the information problem. This implies that disciplinary dismissals will not be costless. Firing costs in turn will have a negative effect on aggregate employment because they modify the rent that has to be paid to workers to prevent shirking. We also find that the solution to the problem does not necessarily imply the elimination of firing costs.