Does Employment Protection Reduce Productivity?: An analysis using Basic Survey of Japanese Business Structure and Activities microdata

The purpose of this paper is to examine the impact on firm-level productivity of Japan's regulatory restrictions on the dismissal of employees. First, with regard to the route through which restrictions on employee dismissal affect firm-level productivity we set out hypotheses indicated by economic theory, and we then use firm-level microdata to conduct an empirical analysis of the impact on firm-level productivity of Japan's regulatory restrictions on employee dismissal. From the results of this analysis we learn that companies' total factor productivity growth is significantly lower when there is a relatively high cumulative number of court rulings voiding employee dismissals. In addition, although we do not observe that the stiffening of restrictions on dismissals stimulates the substitution of labor by capital inputs, it is clear that there is a significant overall lowering of labor productivity. The effect of employment protection for specific workers does not remain solely at the level of the labor market, and by exerting a negative impact on firm-level productivity it impacts the entire economy.