The joint design of unemployment insurance and employment protection. A first pass.∗

Unemployment insurance and employment protection are typically discussed and studied in isolation. In this paper, we argue that they are tightly linked, and we focus on their joint optimal design. We start our analysis with a simple benchmark, with risk averse workers, risk neutral firms, and random shocks to productivity. In this benchmark, we show that 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: 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. The scope for insurance may be more limited than in the benchmark; so may the scope for employment protection. The general principle remains however, namely the need to look at unemployment insurance and employment protection together, rather than in isolation. ∗We are grateful to Daron Acemoglu, Suman Basu, Larry Katz, Javier Ortega, John Hassler, and Aleh Tsyvinski for helpful comments. †MIT and NBER. ‡IDEI and GREMAQ (UMR 5604 CNRS), Toulouse, and MIT.