Yes, according to the OECD, IMF, and the conventional view among many academics. The simple intuition that if you make it more difficult to fire workers employers will be less willing to create new jobs, and that in a dynamic economy this will lead to higher unemployment, seems compelling enough. Plus, there is a large number of cross-country econometric studies that apparently show labor-market protections, particularly unemployment benefits, to be correlated with unemployment levels.
A new paper by Howell, Baker, Glyn, and Schmitt reviews this empirical literature and finds it badly wanting.
The main culprits are held to be protective institutions, namely unemployment benefit entitlements, employment protection laws, and trade unions. Our assessment of the evidence offers little support for this orthodox view. The most compelling finding of the cross-country regression literature is the generally significant and robust effect of the standard measure of unemployment benefit generosity, but there are reasons to doubt both the economic importance of this relationship and the direction of causation. The micro evidence on the effects of major changes in benefit generosity on the exit rate out of unemployment has been frequently cited as supportive evidence, but these individual level effects vary widely across studies and, in any case, have no direct implication for changes in the aggregate unemployment rate (due to “composition” and “entitlement” effects). Finally, we find little evidence to suggest that 1990s reforms of core protective labor market institutions can explain much of either the success of the “success stories” or the continued high
unemployment of the large continental European countries. We conclude that the evidence is consistent with a more complex reality in which a variety of labor market models can be consistent with good employment performance.
In his comment on this paper, Jim Heckman agrees that the cross-national evidence is weak and fragile. But:
In the absence of better data, and better measurement frameworks, prior beliefs will continue to dominate how one interprets the evidence. This is not as
much about dogmatism or conspiracy as it is about good science. In the absence of empirical evidence, logically consistent stories that accord with intuition have great appeal. At both an intuitive level and at the level of formal economic theory, incentives matter. If a person is paid not to work, the person will likely not work. If the costs of hiring a worker rise, fewer workers are likely to be hired. The microevidence supports these basic predictions of theory. Like the controversy over the effects of minimum wages, disagreements are not over qualitative predictions of the theory, but are about quantitative empirical responses.
HBGS are splendid critics. However, they do not offer a constructive empirical alternative to existing practices in the literature. They have not proved that institutions do not cause the pattern of European unemployment. They have, instead, shown that the current data base and models are too weak to decide the issue.
In at least one area of labor-market intervention, employment protection (firing restrictions), the orthodox expectation is not the only "logically consistent" story that accords with economic intuition. If you make it harder to fire an employee, you essentially give that employee some property rights over the job he occupies. Now, according to the Coase theorem, how property rights are allocated (to the employer versus the employee) has no effect on efficiency in the absence of bargaining and other transaction costs. If eliminating a job is the efficient thing to do, an employer can do it either by fiat or by paying the employee to leave. There are distributional implications (obviously the employer is worse off in the latter case), but nothing to stop the efficient thing from getting done. This is an idea I associate with my Harvard colleague Richard Freeman.
In the real world, there are of course transaction costs, and bargaining between worker and employer is not costless. But automatic dismissal has its own costs. Ultimately an evaluation of the "protective" regime vis-a-vis the liberal model is not that straightforward. We have to compare two regimes with different distributional incidence and different sets of transaction costs.
This way of thinking has another implication. Employment protection legislation should have the least adverse effects in systems that facilitate employer-employee bargaining. There is a complementarity between these two elements of labor-market institutions.