Georgia’s current rank in the ease of “hiring and firing practices” and “redundancy costs” (weeks of salary an employer is required to pay a dismissed worker) is 9^th and 13^th, respectively (World Economic Forum’s Global Competitiveness Report, 2012-13). While a matter of pride for Georgia’s previous administration, the liberal labor legislation has become a major bone of contention between the UNM and its many critics (constructive and otherwise), including local labor unions, the International Labor Organization (ILO), the European Union (EU) and the US. The EU, to take one example, made labor reforms a condition for deeper trade integration with Georgia. The concern shared by all critics is that the current labor code unnecessarily strengthens employers’ positions and undermines the rights of employees. This criticism finds additional support in the fact that Georgia’s “flexible” labor market has failed to create jobs (despite the impressive economic growth of recent years)!

Eager to address popular demands and the criticism coming from the international community, the newly elected government launched a process of consultations that are supposed to lead to a reform of the labor code. As part of this process, a very lively debate between those in favor and against labor code reforms is taking place in recent months. It has thus become increasingly common to hear and read about bold statements predicting very positive or very negative outcomes, was this or that change in the labor code implemented (or were the labor code to remain unchanged). Unfortunately, many of these statements seem to be ideologically motivated and/or based on misconceptions about how the labor markets work as opposed to a rigorous and well-documented analysis.

As a young economist working on labor market issues, I was excited by the opportunity to participate in this debate and listen to some of the parties involved in the labor code reform process. Yet, I came out of the meetings with mixed feelings. On the one hand, it was good to see that all participants – policymakers, researchers, and the Georgian Trade Union Confederation – seem to want a better future for the country and care about workers. On the other hand, I was surprised and worried by what seemed to be a lack of understanding of the underlying “economics fundamentals” and the implications associated with the options on the table.

YOU ARE FIRED! WELL, NOT SO FAST…

One of the proposed changes to the labor code is about forcing employers to bear the burden of proof when dismissing employees. Accordingly, workers will have the right to receive a written statement of the reasons for their dismissal. Moreover, a) they would be entitled to appeal their employer’s decision within 30 days of dismissal and b) courts would have the authority to require employers to reinstate laid-off workers or provide them with equivalent work if the act of dismissal is deemed illegal.

Evidently, the main goal of this amendment is to make it more difficult for employers to fire without reason or for a wrong reason (e.g. discrimination on the basis of gender, ethnicity, and/or political preferences). Yet – and this is a crucial point – it will also make more it more difficult for employers to dismiss workers for other, legitimate reasons. This will be particularly the case if the new law provides a restricted list of specific violations that are recognized as valid causes for contract termination, therefore further limiting employers’ capability to fire.

Those in favor of this legislative change do not seem overly concerned with the impact it might have on labor market outcomes and are confident that it will significantly improve workers’ job security. Those opposing, however, are afraid that it might have disastrous consequences for the Georgian labor market, reducing the incentives to invest, create jobs and hire, leading to ever-increasing unemployment.

To what extent are these hopes and concerns justified? What can we say about potential outcomes was this change in the Georgian labor code to be implemented?

Light dismissal procedures are indeed one of the core elements for the functioning of a flexible labor market. In the fast-paced modern business environment, one has to be able to immediately and flexibly react to changes in market conditions, and any tightening of firing procedures lowers the flexibility of employers to react to such changes. Another justification for light regulation is that hiring is done in a situation of “information asymmetry”. Employers can never be sure that a person is really suitable for the job. If, unfortunately, this turns out to not be the case, employers would like to be able to fire as easily as possible. On the other hand, at least in theory, excessive ease of firing might reduce the incentives for workers to invest in firm-specific human capital, leading to a lack of loyalty, low morale, and low productivity.

Importantly, the proposed change is not entirely positive even from the workers’ point of view. For example, an issue that is often overlooked is that tighter regulation of labor relations and employment contract dissolution may result in the division of the labor market between a segment of permanently employed and relatively well-protected "insiders" and a group of disadvantaged "outsiders". The reason for this is that a tightening of dismissal procedures may have a negative effect on the creation of new employment opportunities. Thus, the job security of insiders will be achieved at the expense of outsiders not being able to enter the labor market. This, according to Rutkowski (2003), was the case of Croatia, where “low hiring is a mirror image of low firing and considerable job stability enjoyed by the insiders. The high level of protection of the interests of those who have jobs substantially raises implicit labor costs and, consequently, makes employers reluctant to hire new workers. Those who pay the price are the outsiders: new entrants to the labor market (mainly youth) and job losers.”

At the aggregate (macroeconomic) level, existing evidence suggests that stronger employment protection does lead to less job reallocation – an important condition for effective structural change and modernization (Haltiwanger, J., Scarpetta, S., and Schweiger, H., 2010). However, the extent to which it slows down economic growth is not certain. So, while it is certainly true that tighter labor regulation will affect the managerial practices and the relative strength of employers and employees, the final outcomes for employees, firms, and the entire economy, are far from clear. In the end, job security, better working conditions, and decent wages are best secured in a fast-growing, competitive environment in which employers hunt for talent and seek to nurture and retain it. If unreasonably stringent and excessively “well” enforced by the courts, tighter labor market regulation may lead to a lose-lose situation, preventing Georgia from creating such an environment and moving up the ladder of economic and human development.

To conclude, labor market policies should be based on rigorous analysis of how a given labor market works, as well as careful monitoring and evaluation of the effects of implemented policy changes, rather than on ideology or pre-existing beliefs. I do not think that economists can predict everything; however, they are certainly well equipped to identify the shortcomings of well-meaning but poorly designed policies and to suggest ways to improve them. One would hope that Georgian policymakers will increasingly seek economists’ advice and take it into account when drafting new policies that might affect the future of our nation.

References:

Haltiwanger, J., Scarpetta, S. and Schweiger, H., 2010. “Cross country differences in job reallocation: the role of industry, firm size and regulations”. EBRD Working Paper No. 116

Rutkowski J. 2003. “Does Strict Employment Protection Discourage Job Creation? Evidence from Croatia”. World Bank Policy ResearchWorking Paper 3104.