Do Stronger Legal Rights For Workers Depress Hiring?

American employers' freedom to "fire workers at will" used to be the envy of their European counterparts. But in the 1980s, even as Europe began to ease restrictions on employers, some 45 states embraced legal doctrines that gave workers new protection, often allowing plaintiffs to receive punitive damages as well as lost wages.

Now, a Rand Corp. study concludes that these legal views may be "inflicting substantial economic costs on the nation." In essence, the threat of wrongful-termination suits seems to be changing companies' human-resource practices in ways that boost business costs and increase incentives to curb payrolls.

The study's authors, James N. Dertouzos and Lynn A. Karoly, note that the the new doctrines may be inspiring some employers to keep poor performers on the job rather than fire them, and to give fired employees high severance payments in return for waivers of litigation. But their main focus is on the observable labor-market effects--that is, on hiring practices.

Evaluating the legal environments in all states, the two economists find that the scope of the new doctrines and the possible size of damage awards in a state have held down long-run hiring by local businesses. Particularly in large companies and in finance and service industries, the threat of litigation has reduced employment levels by 2% to 5% from where they would otherwise be.

The irony is that employers appear to be vastly overreacting to the new climate. The two economists calculate that the direct costs of wrongful-termination litigation--lawyers' fees, jury awards, and settlements--are surprisingly small, amounting to only about 0.1% of an average company's total wage bill. That's mainly because such suits occur only in a small percentage of terminations. Yet companies are sizing their work forces as if such suits were adding 10% to their wage bill--a response that imposes significant costs on the companies, the economy, and prospective employees.

Why are companies behaving so irrationally? One possibility, say Dertouzos and Karoly, is that they may be reacting to news of huge headline-making awards that are actually very rare.

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