The Elusive Effect of Employment Protection on Labor Turnover

For a large sample of Italian firms, we analyze employment adjustments to external wage shocks under different EPL regimes. The responsiveness of labor quantity to wages is shown to be systematically higher under stricter regulation. We explain this counterintuitive result arguing that the effect of labour regula- tion is twofold: on the one hand, it increases the cost of dismissals; on the other, along with the greater presence of unions, it reduces the monopsonistic power of employers and induces higher firm-level labor supply elasticity. This is confirmed by the analysis of the effects of a tax induced shift of the labor de- mand. Hence, although labor demand elasticity is arguably lower for regulated firms, wage shocks may result in larger employment variations. Our results motivate to reconsider labor deregulation as the key for improving employment reallocation.