Great Expectations: Law, Employment Contracts,and Labor Market Performance

This chapter reviews the literature on employment and labor law. The goal of the review is tounderstand why every jurisdiction in the world has extensive employment law, particularlyemployment protection law, while most economic analysis of the law suggests that lessemployment protection would enhance welfare. The review has three parts. The first partdiscusses the structure of the common law and the evolution of employment protection law.The second part discusses the economic theory of contract. Finally, the empirical literatureon employment and labor law is reviewed. I conclude that many aspects of employment laware consistent with the economic theory of contract – namely, that contracts are written andenforced to enhance ex ante match efficiency in the presence of asymmetric information andrelationship specific investments. In contrast, empirical labor market research focuses uponex post match efficiency in the face of an exogenous productivity shock. Hence, in order tounderstand the form and structure of existing employment law we need better empirical toolsto assess the ex ante benefits of employment contracts...