Two Tier Reforms of Employment Protection: A Honeymoon Effect?

Abstract

Labour market reforms increasing flexibility ‘at the margin’ have been recently paying out in terms of employment growth. This article argues that two‐tier labour market reforms have a transitional ‘honeymoon’, job creating effect. In a dynamic model of labour demand under uncertainty, the article predicts that in the aftermath of reforms, beyond an increase in employment, there should be a reduction in ‘employment inaction’ and in the mean and cross‐sectional variance of labour productivity. Based on a variety of firm‐level data on Italy in the period 1995–2000, we find evidence of our empirical implications.