In this week’s Grumpy Economist Weekly Rant, John Cochrane examines how strict firing rules can weaken the very labor markets they are meant to protect. Drawing on examples from Europe, he explains how mandatory severance requirements, social selection tests, and limits on dismissals raise the cost of hiring by making employment decisions harder to reverse.
Cochrane argues that the broader economic cost is not only higher unemployment, but weaker innovation. When firms cannot easily experiment, fail, and reallocate workers to new ventures, they become less willing to take risks. The result is a labor market that may protect existing jobs, but discourages new firms, new technologies, and the dynamism that makes workers better off over time.
Transcript
Hi. I’m John Cochrane, senior fellow here at the Hoover Institution, and welcome to my Grumpy Economist Weekly Rant.
Today we’ll talk about, if you want to hire people, you gotta fire people. I’m inspired this week, channeling two blog posts by Peter Garicano and Brian Albrecht, and thoughts from the visit to Stanford by Mario Draghi, ex-head of the European Central Bank and prime minister of Italy.
It costs a lot to fire people in Europe. In Germany, you have to pay mandatory severance pay, and there’s a social selection test. You have to rank employees by age, years of service, family maintenance obligations, and disability, and then prioritize dismissing people with the weakest social claim to the job.
If you declare yourself a caregiver, you can’t be fired at all for two years, no matter how bad the situation of the company. That’s a lot of costs for companies.
They cite an example of Opel, which wanted to shut down a factory in Germany. It had to spend 500 million euros on severance pay for the 3,000 workers, some of whom got 250,000 euros each, and a 60 million euro plan to get them new jobs.
Garicano cited evidence of the cost in months. In Germany, it costs, on average, 31 months of pay, two and a half years, to fire someone. In France, 38. Italy, 52. Spain, 62. Five years of the employees’ costs in order to be able to fire them.
The US? Seven. Oh, seven, not zero? Yes, voluntarily in the US, many companies offer severance pay to their employees. Why? To attract employees in the first place, and, in some cases, there are non-competes and other reasons that that’s important for the employees. But it’s voluntary. Switzerland, three. Denmark, three. It’s possible, even in Europe.
What are the effects? Well, obviously, if you can’t fire people, it’s hard for people to get jobs. Companies are very picky about who they’re going to hire if hiring someone means you keep them basically until retirement.
And in fact, if the US were so horrible, why is it our unemployment rate is 4.4%? Germany’s 6.3%. France is 7.7%. And Spain, 10%, the lowest it’s ever been.
But Albrecht, Garicano, and Draghi, especially the latter, point out the more important consequence. This kills innovation.
Why does the European Union have no Teslas, no Googles, very little AI? Well, it has high taxes and regulations. California has high taxes and regulations, too. They point to the labor market as the big problem.
In order to succeed, you must be able to fail. You must be able to try new things, and then, when it doesn’t work out, get rid of the employees.
Those employees go somewhere else so that a new company that’s trying something else can have a source of labor and then move on without bankrupting the whole company.
Apple spent 10 billion trying to do a self-driving car. Closed it down. Ford and GM, 20 billion each. Facebook, remember Meta? There are a lot of engineers working on that. Some of them may be working at Facebook for AI, but others are looking for new jobs.
If you can’t fail, you can’t try new things. And Europe’s problem is they can’t try new things.
It’s not so much a lack of employment, but in their words, it shifts activity away from areas where layoffs are possible, and there’s only sure and solid work, especially government-protected work. There’s no risky innovation.
What are the lessons here? Government regulation, we think of as being pro-growth, helping the economy, but no, most of the time, it’s doing just what it does here: hurting growth in order to tip the scales of bilateral negotiations.
But does it actually help? Is all this stuff helping German workers that much more than US workers?
What is the best worker protection? Is it laws that you can’t lose an individual job, or is it the right to, as the country song says, always say, “Take this job and shove it”?
If there’s a competitive market willing to give you a new job the minute you want, you’re far better protected than having a system where once you have a job, you have it forever, and no companies can ever innovate.
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John H. Cochrane is the Rose-Marie and Jack Anderson Senior Fellow of the Hoover Institution at Stanford University. An economist specializing in financial economics and macroeconomics, he is the author of The Fiscal Theory of the Price Level. He also authors a popular Substack called The Grumpy Economist.
