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

We investigate the microeconomic effects 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 multinational food chain operating about 2,840 retail outlets in 43 countries outside the United States. The dataset provides information on output, input costs and labor costs at a weekly frequency over a 4-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 (1) reduces the response of labor cost to a one standard deviation increase in output (revenue) by about 4.5 percentage points (from 26.8 percent to 22.3 percent); and (2) increases the response of labor cost to a one standard deviation increase in lagged labor cost by about 9.6 percentage points (from 17.0 percent to 26.6 percent). Our estimates imply an increase in gross misallocation of labor ranging from 2 to 10 percent of total labor costs, for an increase in the index of labor regulation from the 25th to the 75th percentile. Finally, we find evidence that the Company delayed entry and operates fewer outlets in countries with more rigid labor laws. Overall, the data imply a significant impact of labor laws on labor adjustment and related decisions at the micro level.