The Microeconomic Implications of Input Market Regulations: Cross-Country Evidence from Within the Firm

We investigate the microeconomic implications of labor regulations that protect employment and are expected to increase rigidity in labor markets. We exploit a unique outlet-level dataset obtained from a multi-national food chain operating about 2840 retail outlets in over 48 countries outside the US. The dataset provides information on output, input costs and labor costs at a weekly frequency over a four year period, allowing us to examine the consequences of increased rigidity at a much more detailed level than has been possible with commonly available annual frequency or aggregate data. We find that higher levels of the index of labor market rigidity are associated with significantly lower output elasticity of labor demand, as well as significantly higher levels of hysteresis (measured as the elasticity of current labor costs with respect to the previous week’s). Specifically, an increase of one standard deviation in the labor regulation rigidity index (i) reduces the response of labor cost to a one standard deviation increase in output (revenue) by about 4.7 percentage points (from 27.2 per cent to 22.5 percent); and (ii) increases the response of labor cost to a one standard deviation increase in lagged labor cost by about 9.6 percentage points (from 17.8 per cent to 27.4 per cent). Our estimates imply an increase in gross misallocation of labor of about 2 to 5 per cent for a one standard deviation increase in the index of labor regulation. Finally, we find evidence that the Company delayed entry, operates fewer outlets and favors franchising in countries with more rigid labor laws. Overall, the data implies a strong impact of rigid labor laws on labor input and related decisions at the micro level. ∗Stephen M Ross School of Business, University of Michigan, email: [email protected], [email protected]. We thank Kathryn Shaw, Richard Freeman, Jan Svejnar and participants at seminars at the University of Colorado and the University of California, Berkeley for their comments. All remaining errors are our own.