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German Working Papers in Law and Economics
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Volume 2002

Thomas Eger

Opportunistic Termination of Employment Contracts and Legal Protection Against Dismissal in Germany and the USA

Thomas Eger (2002) "Opportunistic Termination of Employment Contracts and Legal Protection Against Dismissal in Germany and the USA", German Working Papers in Law and Economics: Vol. 2002: Article 11.

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When analysing labour law most lawyers tend to focus on the protection of existing employment relations and to neglect the feedback on employers’ ex-ante incentives to create new and to sustain existing jobs. In contrast to that view, most economists focus on the incentives to create and to sustain jobs, but usually lack information on the regulations and relevant court decisions in detail. Since the late 80s many cross-country comparisons have been carried out in order to estimate the influence of employment protection on employment, unemployment rates and other indicators. Most of these studies have come to the conclusion that there is no significant impact of employment protection on unemployment rates, but that there is a significant positive impact of legal protection against dismissal on the share of long-term unemployment. The most prominent exception to these studies is Lazear (1990) whose study is based, however, on a very crude indicator for employment protection. This paper analyses the protection against individual and collective dismissals from a comparative Law-and-Economics point of view, and compares two countries: Germany which is often criticised for its supposed rigid and inefficient employment protection, and the USA which have been usually perceived as a typical example of a very flexible labour market where employers are allowed to hire and fire workers at will, i.e. (almost) without any legal constraint. In section 2, I analyse the incentive-structure of contractual or legal protection against dismissal. Here, emphasis is put on the link between protection against dismissal and the incentive to invest in firm-specific human capital. It is shown that some degree of protection against unfair dismissal might increase efficiency, and that market failures will prevent employers and employees from voluntarily agreeing on all mutually beneficial constraints regarding dismissals. Legal protection against dismissal helps to avoid such problems but might create other problems. In sections 3 and 4 the relevant elements of legal protection against dismissal in Germany and the US are presented, and it is discussed how these elements influence employers’ expected labour costs and thereby their incentives to create and to sustain jobs. Finally, in section 5, some typical links between employment protection, the level and composition of skills, and the technology and organisation of production are discussed. An analytical framework is provided which characterises both countries as different varieties of capitalism. It is shown what provisions of German law should be amended in order to promote efficiency without destroying the socially beneficial effects of a well designed protection against unfair dismissal.

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