No free lunch: The economic consequences of job dismissal laws

by Dan Andrews and Jack Buckley

New research by the e61 Institute examines the economic consequences of stricter job dismissal laws for firms, workers and productivity. To do so we study the impact of the introduction of the Fair Work Act in 2009, which brought about the equal largest tightening of dismissal laws in the OECD.

We find that the tightening of job dismissal laws caused a sharp 5% drop in job separations, suggesting that it served its intended purpose of protecting workers against dismissal.

But there was no free lunch. Firms adjusted to the new laws in ways that yielded unintended consequences:

  • In casualised industries (e.g. hospitality and retail), firms temporarily increased their hiring activity, seemingly adjusting to the new laws by hiring more flexible casual workers.
  • In industries where hiring casual workers was less feasible (e.g. manufacturing), firms substituted less flexible labour for more flexible capital (machines, computers etc.).

And because the new laws distorted input choices and made it more difficult for firms to adjust their workforce, firm productivity fell by 1.2%.

These findings have important implications for policy:

  1. A reminder that firms are sensitive to changes in market regulations and can adjust in ways that carry unintended consequences.
  2. Debates over the adequacy of the social safety net and labour market regulations should look for potential policy complementarities.
  3. Policy makers should do more to target policy changes – such as the removal of non-compete clauses – that would not entail an equity-growth trade-off.