DP6127 The Joint Design of Unemployment Insurance and Employment Protection. A First Pass

Author(s): Olivier J Blanchard , Jean Tirole

Publication Date: February 2007

Keyword(s): employment protection , experience rating , layoff taxes , layoffs , severance payments , unemployment benefits , Unemployment insurance

JEL(s): D60 , E62 , H21 , J30 , J32 , J38 , J65

Programme Areas: Public Policy

Link to this Page: www.cepr.org/pubs/dps/DP6127.asp.asp

Unemployment insurance and employment protection are typically discussed and studied in isolation. ln this paper, we argue that they are tightly linked, and we focus on their joint optimal design in a simple model, with risk averse workers, risk neutral firms, and random shocks to productivity. We show that, in the 'first best', unemployment insurance comes with employment protection - in the form of layoff taxes; indeed, optimality requires that layoff taxes be equal to unemployment benefits. We then explore the implications of four broad categories of deviations from first best: limits on insurance, limits on layoff taxes, ex-post wage bargaining, and ex-ante heterogeneity of firms or workers. We show how the design must be modified in each case. Finally, we draw out the implications of our analysis for current policy debates and reform proposals, from the financing of unemployment insurance, to the respective roles of severance payments and unemployment benefits.