Sales volatility and labour market rigidity

Cunat and Melitz (2007) proposed that differences across countries in labour market characteristics determine how firms adjust to idiosyncratic shocks and that they interact with sector-specific differences in demand volatility to generate a new source of comparative advantage. Specifically, they found that countries with more flexible labour markets tend to specialise in sectors with higher volatility of demand. This chapter follows this hypothesis and includes interactions of selected indicators of labour market regulation measured at the exporter level with an indicator of sectoral demand volatility.

There are a number of sources of information on labour market institutions including the subcategory of World Bank Doing Business Database on Employing Workers or the OECD Indicators of Employment Protection. However, country and time-coverage considerations as well as the extent of the covered detail and time variation in the data11 led us to adopt indicators of regulation of labour markets developed by Botero (2004). This dataset covers legal rules in 85 countries in year 1997 and encompasses three types of laws: employment laws; collective relations; and social security laws, from which we retain the first two on the basis of more direct relevance of these laws for adjustment to economic shocks. Employment laws govern the individual employment contract. Collective or industrial relations laws regulate the bargaining, adoption, and enforcement of collective agreements, the organisation of trade unions, and the industrial action by workers and employers. As proposed by Cunat and Melitz (2007) these regulations may impose rigidities and prevent markets from adjusting to economic shocks by raising the cost for firms to hire workers and the cost of adjusting employment levels. For example, laws that raise the cost of employment adjustment, in particular those related to employment protection tend to reduce the inflow into unemployment, make firms more careful about hiring employees, and reduce the flow out of unemployment.

The following measures of labour regulation from Botero et al. (2004) are used in our study. Alternative contracts measures the existence and cost of alternatives to the standard employment contract. Cost of increasing hours worked measures the cost of increasing the number of hours worked. Cost of firing workers measures the cost of firing 20% of the firm’s workers. Dismissal Procedures measures worker protection granted by law or mandatory collective agreements against dismissal. Labour Union Power measures the statutory protection and power of unions as the average of seven indicator variables indicating the presence of absence of various unionization rights and obligations. Collective Disputes measures the protection of workers during collective disputes as the average of eight more detailed indicator variables measuring presence or laws protecting industrial action. All of these indicators are constructed so that a higher indicator marks more rigid regulations. The adopted measure of sector-level sales volatility comes from

Braun (2003) who estimated sales volatility using data for all publically traded US-based companies from Compustat’s annual industrial files.12

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