published in: Giornale degli Economisti e Annali di Economia, 2004, 33 (1), 33 - 68
The existing literature ignores the fact that in most European countries the strictness of
Employment Protection Legislation (EPL) varies across the firm size distribution. In Italy firms
are obliged to rehire an unfairly dismissed worker only if they employ more than 15
employees. Theoretically, the paper solves a baseline model of EPL with threshold effects,
and shows that firms close to the threshold are characterized by an increase in inaction and
by a reluctance to grow. Empirically, the paper estimates transition probability matrices on
firm level employment using a longitudinal data set based on Italian Social Security (INPS)
records, and finds two results. First, firms close to the 15 employees threshold experience an
increase in persistence of 1.5 percent with respect to a baseline statistical model. Second,
firms with 15 employees are more likely to move backward than upward. Finally, the paper
tests the effect of a 1990 reform which tightened the regulation on individual dismissal only
for small firms. It finds that the persistence of small firms relative to large firms increased
significantly. Overall, these threshold effects are significant and robust, but quantitatively
small.
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