JOURNAL OF ECONOMIC ISSUES Vol. XLI No.

4 December 2007

The Importance of Legislated Employment Protection for Worker Commitment in Coordinated Market Economies

Mark Harcourt, Geoffrey Wood and Ian Roper

This article extends contemporary debates about corporate governance, institutions, and firm-level behavioral effects, with a more systematic analysis of how one institution, legislated employment protection (employment security), deepens the reliance of firms in coordinated market economies (CMEs) on cooperative employeremployee relations for their competitive success (c.f. Whitley 1999, 38; Wood 2001, 252). This represents a meso or mid-level approach, as opposed to existing studies, which adopt a micro-level focus on industry case studies or a macro-level focus on cross-national differences in entire clusters of employment practices. We begin with a brief overview of two schools of institutional thought: varieties of capitalism (VOC) and regulation theory (RT). We then define and describe the key elements of legislated employment protection (employment security) as an institution, in addition to how these elements differ across CME countries, and between CMEs and the United States, the liberal market economy (LME) with the least employment protection. We then discuss the importance of worker commitment to CME economic success, and the crucial part played by legislated employment protection in engendering that commitment. We acknowledge that legislated employment protection may have negative lethargy effects, but argue that these are potentially less damaging in CMEs than LMEs for the same degree of protection. Next, we suggest practical ways that CMEs might modify legislated employment protection to both allay the negative lethargy effects and enhance the positive commitment effects. Finally, we conclude by stressing that despite its economic importance, legislated employment protection in CMEs remains politically fragile, in being vulnerable to attack by employers pursuing narrow, private interests.

Dr. Mark Harcourt is a Professor in the Department of Strategy and HRM, Waikato Management School, University of Waikato, Hamilton, New Zealand. Dr. Geoffrey Wood is a Professor in the Department of HRM and OB, Management School, University of Sheffield, 9 Mappin St., Sheffield, United Kingdom. Dr. Ian Roper is a Senior Lecturer in the Department of Human Resource Management, Middlesex University, The Burroughs, Hendon, London, United Kingdom. The authors would like to thank the anonymous referees for their very helpful comments.

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Mark Harcourt, Geoffrey Wood and Ian Roper Introducing Varieties of Capitalism and Regulation Theory

The Varieties of Capitalism Approach Variation in national macroeconomic performance over the last 35 years has stimulated research interest in the institutional foundations of national competitiveness. Two groups of modern institutionalists, the proponents of so-called VOC and RT, have been especially interested in explaining comparative economic performance in terms of institutions. Like Veblen, Commons, and the other old institutional economists, these modern theorists (Gooderham, Nordhaug, and Ringdal 2006, 1492) believe that the notion of individual agents as utilitymaximizing is . . . inadequate or erroneous (c.f. Hodgson 2000, 318). Individual behavior is instead shaped by a social structure and order expressed in, and conditioned by, institutions (Albert and Ramstad 1998), especially legal institutions, in the view of John R. Commons (Hodgson 2003). Institutions can affect individual behavior in three ways. First, they have a restrictive function in constraining behavior. Second, they have a cognitive function in: a) transmitting information to individuals about what others will and will not do; and b) influencing the way in which people perceive reality. Third, and not unrelated, they have a motivational or teleological function in influencing the goals people decide to pursue (Dequech 2002, 566). Both VOC and RT theorists believe that behavior is shaped by social structure, laws, and informal regulation, but RT theorists see legislative interventions varying more in effectiveness, with any accommodation between competing societal interests invariably contested as the balance of social forces and external pressures shift. The RT view of institutions is thus more obviously dynamic: institutions provide a temporary basis for mediating and framing social exchanges, allowing for periods of growth (Hollingsworth 2006). VOC scholars focus on how societal rules, norms, practices and cultural factors mold specific patterns of firm-level practice (Gooderham, Nordhaug, and Ringdal 2006, 1493). They draw key distinctions between those developed countries characterized as liberal market economies (LMEs), the United States and most other developed Anglophone economies, and coordinated market economies (CMEs), Japan, Germany and most of northern Europe (see Dore 1986; Lincoln and Kalleberg 1990; Hall and Soskice 2001). In general, LME institutions stress the primacy of shareholder value maximization and shareholder rights, whereas CME institutions focus more on long-term national interests and reconciling the often-conflicting interests of key stakeholders, especially organized labor and capital. Each system encourages and constrains particular patterns of organizational practice (Dore 2000). The idea of path dependence, with national varieties of capitalism evolving along distinct, linear trajectories, is central to the VOC literature (Hollingsworth 2006).

The Importance of Legislated Employment Protection Critiques and Developments

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In contrast, proponents of regulation theory (RT), though also concerned with cross-national regulatory and governance differences, argue that LMEs and CMEs have both had to change in response to the crisis of Fordism1 in the early 1970s (Jessop 2001). To regulationists, any form of institutional mediation is necessarily temporary and subject to a non-linear process of evolution. Quite simply, there is no guarantee that a particular set of institutional arrangements functional in one particular time and place will be similarly functional later or elsewhere. During the 1980s and early 1990s, both schools of thought concerned themselves with critically evaluating the relative merits and demerits of LMEs versus CMEs, often expressing a clear preference for the latter over the former (Jessop 2001; Dore 2000; Lincoln and Kalleberg 1990). However, the resurgent performance of LME economies, particularly the United States, in the 1990s and early 2000s has challenged any assumption that there might be one best model of capitalism (Jessop 2001). Nonetheless, VOC and RT scholars remain doubtful about the desirability of the LME model for two reasons. First, LMEs remain prone to speculative bubbles and associated economic volatility (Brenner 2002). Second, in stressing shareholder wealth maximization, LMEs focus too narrowly on one set of interests, those of shortterm corporate capital, at the potential expense of other interests and values. Advocates of the LME model claim that this is essential: corporate profitability must receive priority over other goals like the quality of working life; the pursuit of the latter must necessarily come at the expense of the former. However, VOC and RT institutionalists argue for the mutually reinforcing complementarity of labor and capital interests in CME capitalism. In a negotiated, national settlement, the parties can together devise win-win solutions, workplace practices and institutions, which are functional to the interests of both and involve no obvious, major loss of efficiency, at least in the long-run (c.f. Jessop 2001; Boyer 2006). Legislated Unjust Dismissal Protection Defining Employment Protection Legislated employment protection or employment security typically refers to a variety of mandatory practices that deliberately make it harder and/or more expensive to dismiss employees. These practices typically include severance payments and/or advance notice for redundant workers, dismissal procedures that adhere to rules of natural justice, and permitting dismissals only where there is just cause. Where available, severance payments typically vary with years of service and salary. Sometimes, severance payments are only owed if the employer provides insufficient advance notice. The period of advance notice usually depends upon the workers years of service and sometimes the number of redundancies among other factors. Dismissal procedures are generally quasi-judicial in nature, and entail at least some worker

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involvement. This may vary from simply informing workers of why and how they have been selected for redundancy to involving workers or their representatives in making dismissal decisions through works councils. Just causes for dismissal ordinarily fall into three categories: worker performance, worker misconduct, and redundancy. Performance ordinarily covers issues like incompetence and incompatibility, where there is no obvious, willful attempt to do harm to the employers interests. In contrast, misconduct typically involves willful violations of duties or rules that undermine the employers interests. Examples include dishonesty, disobedience, disloyalty, and negligence. Redundancy may be defined broadly or narrowly. A broader notion of redundancy allows employers to sack employees whenever their jobs are eliminated. No reason for eliminating the jobs need be given. A narrower notion of redundancy permits employers to only eliminate jobs and sack their incumbents in a narrow range of circumstances such as bankruptcy and insolvency. Employment Protection in Comparative Context Table 1 outlines the degree of legislated employment protection for a selection of CME and LME countries. It shows that CMEs (like the Netherlands and Germany) have substantially more protection than LMEs (like the United Kingdom and United States), despite a trend toward less protection. CMEs in Europe also differ considerably in the extent and nature of their employment protection (Abraham and Houseman 1993; Bertola, Boeri, and Cazes 2000; Kraft 1997; Morin and Vicens 2001). For instance, just-cause rules allow redundancies in wider circumstances in Germany than France, but, in requiring greater levels of worker involvement, Germanys dismissal procedures are in many ways more onerous than Frances (Morin and Vicens 2001). Despite such differences, CME governments have shared a common objective in providing some degree of employment security, at least to permanent, full-time employees. At the other LME extreme, the United States only affords employment protection to civil servants and, via negotiated provisions in collective agreements, to unionized workers. The bulk of nonunion, private sector workers are covered by an official policy of employment-at-will (Barber 1993, 166). This essentially allows employers to fire people for any or no reason and without having to provide advance notice or severance payments. However, over the last thirty years, the courts have circumscribed this policy, though only marginally, by providing just-cause employment protection in three situations: when the employee is dismissed for complying with U.S. law, when the dismissal involves discrimination on a prohibited ground, and when employer promises of job security constitute an implied term in the employees contract (Miles 2000). In addition, the 1988 Worker Adjustment and Retraining Notification (WARN) Act requires employers outside the state and federal civil services to provide employees with 60 days advance notice of termination for plant closings and mass dismissals of 500 or more workers (Eger 2004, 396).

The Importance of Legislated Employment Protection Table 1. Summary Indicators of the Strictness of Employment Protection Legislation*
Nature of Employment Contract Regular(1) Temp.(2) Collective Dismissals(3) Overall EPL strictness: Version 1# Late 1990s 2.2 2.2 0.8 1.4 2.1 3.0 2.5 2.1 2.7 2.2 0.6 0.2 Overall EPL strictness: Version 1# 2003 1.9 2.2 0.8 1.4 2.0 3.0 2.2 2.1 2.6 2.2 0.7 0.2 Overall EPL strictness: Version 2## Late 1990s 2.4 2.5 1.1 1.8 2.2 2.8 2.6 2.3 2.7 2.6 1.0 0.7

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Overall EPL strictness: Version 2## 2003 2.2 2.5 1.1 1.8 2.1 2.9 2.5 2.3 2.6 2.6 1.1 0.7

Country AustriaA BelgiumA CanadaB DenmarkA FinlandA FranceA GermanyA NetherlandsA NorwayA SwedenA United KingdomB USAB

2003 2.4 1.7 1.3 1.5 2.2 2.5 2.7 3.1 2.3 2.9 1.1 0.2

2003 1.5 2.6 0.3 1.4 1.9 3.6 1.8 1.2 2.9 1.6 0.4 0.3

2003 3.3 4.1 2.9 3.9 2.6 2.1 3.8 3.0 2.9 4.5 2.9 2.9

*Note on methodology of indices: These indices were compiled by the OECD (2004). Employment protection is described in terms of 18 basic items, divided into three categories. These are the employment protection of individual workers from regular dismissals, the particular requirements for collective dismissals, and the regulation of temporary employment contracts (OECD 2004). These are then distilled into four cardinal summary indicators that are widely recognized as a comparative summary of employment protection legislation. A full discussion of the methodology employed may be found in OECD (2004). (1) Composite index compiled from the strength of regular procedural inconveniences (nature of procedures and delay to start notice), the notice and severance pay for no fault individuals dismissal), and the difficulty of unfair dismissal (definition of unfair dismissal, trial period before eligibility starts, unfair dismissal compensation, and extent of reinstatement) (2) Composite index compiled from the strength of inconveniences in the case of temporary employment. (3) Composite index (definition of collective dismissal, additional notification requirements, additional delays involved, other special costs to employers [additional severance pay requirements in the case of collective dismissal and whether social compensation plans apply]) # = Average of indicators for regular contracts and temporary contracts ## = Weighted index of indicators for regular contracts, temporary contracts and collective dismissals A = Coordinated Market Economies B = Liberal Market Economies (Data Source: OECD 2004)

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Worker Commitment: A Positive Effect of Legislated Employment Protection Worker Commitment and Varieties of Capitalism Worker commitment to the firm and its goals is more important to CME than LME capitalism, because of the formers greater dependence on skilled labor. CME firms are particularly reliant on the synthetic or engineering knowledge of workers, often only accumulated with years of experience in the same firm or industry, for a competitive advantage, especially in manufacturing industrial inputs in small batches to particular customer specifications (Asheim and Coenen 2006; Haake 2002; Thelen 2001). Success is achieved through product differentiation, with emphasis given to durability, reliability, and performance (Streeck 1992). LME economies are more bifurcated in their reliance on skills (Estevez-Abe, Iversen, and Soskice 2001). Innovation-driven industries like computers, advertising, banking, and pharmaceuticals depend on the analytical or scientific knowledge of their workers, often obtained while at university (Asheim and Coenen 2006; Haake 2002; Leborgne and Lipietz 2001). However, most firms in the small business service sector and in traditional manufacturing industries, producing highly standardized goods for mass consumer markets, rely heavily on relatively unskilled labor, usually poorly paid, working in Taylorist2 production environments (Estevez-Abe, Iversen, and Soskice 2001). Skilled workers cannot be easily directed and controlled through direct supervision and bureaucratic rules. What skilled workers do is often too varied and complex to reduce to the standard operating procedures of a bureaucracy. Task complexity, what Ouchi (1979; 1980) refers to as low task analyzability, also makes it difficult for supervisors to accurately assess how well skilled workers are performing by observing their behavior. Likewise, high levels of interdependence between skilled workers, especially when they work in teams, can make it difficult to attribute specific outputs to any one skilled worker, even when such outputs are measurable. As a result, motivating skilled workers to work through traditional incentive and merit pay systems can be problematic. High levels of skill and task autonomy are largely incompatible with traditional Taylorist methods of control (Roobeek 2001). In contrast, high task analyzability makes it easier for managers to detect when unskilled workers are shirking. It also enables managers to develop standard operating procedures, using the time and motion practices of scientific management, to prescribe efficient work practices. Managers can then use discipline, and particularly the threat of discharge, to ensure efficient compliance with such work rules. This is the traditional model of management advocated by Frederick Winslow Taylor, and so widely practiced in the United States and other English-speaking developed countries (see Gordon 1998) in industries as diverse as engineering and fast food. It relies heavily on unskilled workers under the direct control of an extensive, multi-layered hierarchy of managers and supervisors, what Marxists have referred to as guard labor. Even accounting for differences in definitions, the evidence suggests that the developed LMEs, and particularly the United States, make

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extensive use of such guard labor as compared to their CME counterparts. Whereas guard labor accounts for perhaps one tenth of the workforce in the United States, it accounts for barely 2-3% in the more developed European countries (Gordon 1998, 191). The effectiveness of guard labor in ensuring compliance with efficient work practices critically depends upon the credibility of the dismissal threat and the potential pain of unemployment (Bowles and Gintis 1990; Shapiro and Stiglitz 1984). In a labor shortage, employers avoid dismissing their workers and those few workers who do get dismissed have an easier time finding a job. As a result, low unemployment diminishes the effectiveness of guard labor as a worker control device. The evidence does show that productivity slowdowns are associated with falling unemployment. However, the effect is small or nonexistent for skilled workers in good, long-term jobs, where guard labor is likely to be both ineffectual and unnecessary (c.f. Spencer 2002). In a study of U.S. manufacturing, Green and Weisskopf (1990) found that unemployment was positively related to work intensity/ labor productivity. However, the relationship was much weaker in so-called primary industries, characterized by unionization, high wages, large employer size, and product market concentration, than in secondary industries. Results suggested that . . . if the unemployment rate rose by 50%, work intensity would rise by just over 9% in a typical most secondary industry but by only 3% in a typical most primary industry (Green and Weisskopf 1990, 247). In a similar study, Rebitzer (1987) also found evidence of an unemployment-related, worker discipline effect, which was muted in industries with long, standardized3 tenure. Finally, Weisskopf (1987) found that periods of low unemployment were strongly associated with productivity slowdowns only in LMEs, not CMEs. Ironically, given recent concerns about high unemployment in some European countries, such findings suggest greater scope for using Keynesian policies to reduce unemployment to low levels in CMEs than in LMEs, mirroring the achievements of the 1960s, when unemployment was generally lower in Europe than in the United States. Skill Based Production and Commitment If skilled workers are hard to control externally through, for example, rules, supervision, and rewards, firms may have to resort to controlling them by instilling the enterprises goals and values or by hiring people who already have such values, what William Ouchi (1979; 1980) calls clan control. In urging U.S. firms to adopt more organization skill-based production systems along European or Japanese lines, several researchers have recognized the need to develop the commitment of skilled workers, using human resource practices like employment security (Pfeffer 1994; Pfeffer and Veiga 1999). How can an institution like legislated employment protection influence worker commitment to the employer? All three institutional influences on individual behavior (Dequech 2002) are relevant here. First, employment protection law plays a

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restrictive function in making it difficult and/or expensive to use dismissals to reduce staffing levels or modify staff behavior, so that alternatives to this practice must be found. Second, it fulfills cognitive functions in raising employee expectations of a long-term relationship with the employer and of a fair hearing in the unlikely event that relationship is terminated, and in convincing both employer and employee that this social order is appropriate and normal. Third, it performs a motivational function in changing the employers and employees goals, in that both pursue more cooperative, long-term relations with each other. The result is that employee commitment to the employer greatly improves, and provides the basis for competitive advantage in a range of industries. All three of these influences are evident in the institutional effects described below. Legislated Employment Protection and Perceptions of Job Security Employment security is typically part of the workers psychological contract with the employer. Continuity of employment is typically an unwritten expectation, even in the United States (Kim 1998; Roehling 2002; Roehling and Winters 2000). Perceived job insecurity, precipitated by threats of redundancy or recent experiences of colleagues being made redundant, may trigger the so-called survivor syndrome. Research shows strong links between perceived and actual job insecurity and key aspects of this syndrome, including intentions to quit (Ashford, Lee and Bobko 1989; Rosenblatt and Ruvio 1996), lower commitment (Adkins, Werbel and Farh 2001; Ashford, Lee and Bobko 1989; Bishop 2002; Buitendach and De Witte 2005; Davy, Kinicki and Scheck 1997; De Witte and Naswall 2003; Yousef 1998), lower commitment to change (Chawla and Kelloway 2004; Pate, Martin and Staines 2000; Preuss and Lautsch 2002; Rosenblatt and Ruvio 1996), and lower performance (Rosenblatt and Ruvio 1996; Yousef 1998). Essentially, workers who feel they have little or no job security cease to trust the employer and resort to self-preservation behavior (McCauley and Kuhnert 1992; Pate, Martin and Staines 2000). Legislated employment protection obviously helps provide workers with some assurance that their jobs are reasonably secure and will not be taken away from them in the absence of due process, compensation, and some advance warning. Legislated Employment Protection and Procedural Fairness Legislated employment protection can also more directly affect commitment by increasing the perceived fairness of dismissals. Folgers (1986) referent cognitions model explains how. Dismissal is obviously a negative outcome for workers. In being associated with such an outcome, the dismissing employer also risks being negatively judged. However, in making such an assessment, the dismissed worker also considers the employers behavior in the dismissal process. More specifically, if an employer acts procedurally fairly, he or she is likely to be dissociated from the negative outcome and forgiven. Research shows that procedural fairness has several key ingredients. First, the victim of dismissal must have some opportunity to influence the dismissal

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decision by expressing his or her own views (Thibault and Walker 1975). Second, the decision-maker, the employer, must apply decision criteria consistently across workers and over time, base his or her decision on accurate information (e.g., facts), and provide the victim with an opportunity to appeal the dismissal decision (Leventhal, Karuza and Fry 1980). Third, the decision-maker must explain the reasons, or grounds, for the dismissal (Bies 1987). These procedures accord, roughly speaking, with those commonly applied in just-dismissal law. Studies show that when these procedures are followed in redundancy situations, victims, survivors, and outside observers all tend to maintain a positive view of the employer. When they are not followed, the opposite occurs (Brockner et al. 1994; Davy, Kinicki and Scheck 1997; Konovsky and Folger 1991; Skarlicki, Ellard and Kelln 1998). Moreover, recent evidence (Pugh, Skarlicki and Passell 2003) suggests that when one employer does not follow just-cause rules, the resentment engendered prompts the victim to resent the new employer. Legislated Employment Protection and Longer Service Legislated employment protection can also indirectly affect commitment by discouraging both voluntary and involuntary turnover so that workers stay longer with any one firm. Workers are less likely to quit, or have any intention to quit, when they believe they have a secure future with their firm. U.S. workers feel less secure about their jobs than their more protected European counterparts and so remain readier to leave (Sousa-Poza 2004). In CMEs, employment protection rules reduce involuntary turnover by prohibiting employers from firing people for no reason, as is lawful under U.S.-style employment-at-will, and by making it more difficult to do so even when there is just cause. As a result, Table 2 shows that worker tenure with any one employer is generally longer in CMEs than in the United States and other LMEs (see OECD 1997; 1999). Longer service with the firm offers at least the potential to build stronger commitment. A worker who stays longer with a firm is more likely to develop strong social ties to other staff, including management, leading to greater harmony and collaboration in the day-to-day workplace environment (Armstrong and Stephens 2005). Constant immersion in the life of a firm is likely to produce assimilation of the firm's culture and endorsement of its goals and values. A close connection over a number of years may promote a perception of mutual dependency between the firms financial performance and the workers financial security, prompting a worker to take more interest in controlling costs, pursuing sales, and raising productivity (c.f. Kochan and Osterman 1994). Longer service workers may have a particularly acute sense of having interests to protect because of pension benefits accrued and above-market pay increases earned in an internal labor market, or because of psychological attachments established to co-workers and the job over a long period. Expectations of a continuing relationship also discourage opportunistic behavior involving, for example, dishonesty or disloyalty, since the party wronged or disadvantaged by such behavior can always retaliate afterward (Cohen 1994).

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Mark Harcourt, Geoffrey Wood and Ian Roper Table 2. Job Tenure in CMEs and LMEs

Coordinated Market Economies Austria Belgium Denmark Finland France Germany Luxembourg Netherlands Sweden Switzerland Liberal Market Economies Australia Canada United Kingdom United States of America

Job Tenure in Years 10.6 11.7 8.5 10.1 11.2 10.3 10.9 9.6 11.5 9.4

6.9 8.1 8.3 6.7

(Source of information: CESifo Group Munich, (1999), Sectoral Differences in Average Job Tenure, 1999 [Table]. Retrieved April 23, 2007, Database for Institutional Comparisons in Europe (DICE), http://portal.ifo.de/pls/diceguest/download/F5552/SECDIF-JOB-TEN.PDF)

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A long-term relationship also provides employers with an opportunity to use benevolent policies and practices to build a more relational psychological contract, with a more open-ended and flexible set of mutual expectations (Bratton and Gold 1999). In the short-term, a worker can ignore or trivialize employer benevolence or attribute it to manipulative motives. In the long-term, a worker cannot easily sustain a negative attitude, and engage in negative behavior toward a benevolent employer without feeling some cognitive dissonance. Accordingly, in the long-term, benevolence builds trust and confidence and encourages reciprocity through organizational citizenship behaviors (c.f. Bratton and Gold 1999). Achieving high levels of commitment obviously saves money, since workers perform tasks beyond their job description for which they might otherwise have been paid. It also saves on supervisory and management costs, since trustworthy workers need less monitoring. The greater dedication and enthusiasm of workers may also mean that workers work harder and therefore more productively. It may also lead to dynamic efficiencies through greater cooperation in innovation. Employment Protection: The Need for Legislation If there are commitment advantages, why make employment protection mandatory through legislation? Offering employment protection when many firms do not, creates an adverse selection problem, the so-called market for lemons problem as first described by Akerloff (1970).4 In the real world, firms often lack good quality information about workers productivity characteristics. Therefore, if a firm offers employment protection, it is likely to attract more of the so-called lemons, workers a firm would probably want to later dismiss because of their incompetence or misconduct. Lemons would value protection more highly than more productive workers less fearful of being fired.5 However, if a firm does not offer employment protection, it is less likely to entice the lemons. As a result, few, if any, firms voluntarily provide employment protection, even though it may be in their collective interest to do so. A classic market failure results, where employment protection, though efficient in many cases, is under-provided. Lethargy: A Negative Effect of Legislated Employment Protection The Lethargy Effect and Employment Security There is an alternative view, which must be acknowledged that employment security actually increases costs and decreases productivity by making workers less willing to work hard. Neo-classical economics assumes that people maximize their satisfaction by engaging in leisure and consuming products. Work is perceived as a bad, a disutility, something to be avoided. Agency theory and transaction cost economics have taken this seemingly self-evident truth to portray workers as shirkers: people who avoid working, if they can, while still earning to afford the products that provide them with real happiness (c.f. Jensen 2000). Shirking is treated as baseline

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behavior, to be modified through the application of various management techniques involving, for example, performance-related rewards and/or behavior or output monitoring. If shirking really is the baseline human condition, legislated employment protection can only encourage shirking by shielding shirkers from dismissal. In discussing the specific case of mandatory severance payments, Suedekum and Ruehmann (2003) refer to this as the lethargy effect. Specifically, more workers may avoid working by coming in late, being absent, not cooperating with management, engaging in misconduct, and working slowly, in the knowledge that management has less power or fewer incentives to dismiss them for such shirking. There is some empirical evidence for the lethargy effect. For instance, Riphahn (2004, 353) found that a higher level of employment protection, which made it almost impossible to fire someone over 40 except for severe misconduct, increased absenteeism by up to 35% in some parts of the German public sector. Public sector workers with high employment protection were absent an average of 16 days per annum, as against 10 days for those with low employment protection. Moreover, public sector workers with low employment protection were absent almost the same number of days per year as their private sector counterparts with similarly low employment protection. The Limited Nature of the Lethargy Effect in Practice The lethargy effect is unlikely to be large for several reasons. For instance, in most jurisdictions with unjust dismissal legislation, employers may still sack someone for irredeemably and unrelentingly poor performance, major misconduct on a first offense, and minor misconduct on a repeated offense. Any shielding from dismissal that does occur is likely to be temporary; bad workers can still be fired, at least eventually. In any event, McCall (2003) argues that depictions of the shirking problem, and the extent to which it has been exacerbated by dismissal protection legislation, have been greatly overstated. The fact is that many workers are motivated by a need for achievement, a need for status or reputation that comes with success, a sense of professional pride, a desire to learn new skills and knowledge, and a sense of interest and fun that comes from engaging with the job. Many are also motivated by a desire for promotion or pay increase that comes with performing well. Accordingly, Suedekum and Ruehmann (2003) argue that the lethargy effect is unlikely to be significant except in boring, low-paid jobs with no long-term career potential, the sort that are more common in the United States than in Europe. However, even in these jobs, the threat of dismissal can only engender the minimum performance levels and rule compliance necessary to avoid dismissal. Most firms can, and must, do more to motivate their workers, especially to achieve and maintain a competitive advantage. To take just four examples, employers cannot realistically rely on threats of punishment to make workers: 1) be cooperative with management; 2) be friendly to customers; 3) be enthusiastic about learning new skills; and 4) be innovative in developing new products and processes.

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The shirking diagnosis of worker behavioral and performance problems is also likely to be incorrect much of the time. Workers perform poorly or engage in misconduct for a variety of reasons, which may have little or nothing to do with shirking, at least in the usual sense. For instance, workers may perform poorly because they have not been adequately trained, resourced, instructed, or mentored. Likewise, workers may engage in misconduct for reasons of anger, confusion, exhaustion, or frustration related to issues as diverse as work overload, unfair treatment, poor communication, personality conflict, and alcoholism. Unjust dismissal legislation requires and/or encourages employers to use voice to tackle these problems by first investigating their causes and then by taking appropriate corrective or alleviating actions before dismissal may even be considered. In the absence of unjust dismissal protection, employers are free to use exit by expelling the poor performer or wrongdoer. Hirschman (1970) argues that exit may simply export performance and misconduct problems to other employers. In exchange, the employer may then import similar problems in hiring other employers workers. In either case, each firms attempt to do what it regards is best, what is privately optimal, actually creates a market failure in which performance and misconduct issues remain largely unresolved and output is permanently lowered. In the worst case scenario, exit may stigmatize a worker whose misconduct or performance problems could have been resolved through voice, rendering him or her permanently unemployable. Practical Implications The Importance of Legislated Employment Protection Legislated employment protection plays an important role in supporting at least some of the key strengths in many CME economies. CME capitalism functions as an at least partially coherent system of mutually reinforcing institutions. While far from perfect, this system nevertheless depends upon the effectiveness of its various contributing components, of which legislated employment protection is one. Abolition of this key component could undermine the entire system by making it more difficult to cultivate mutual trust and confidence. CME firms could find it increasingly difficult to compete in their traditional product lines, such as transportation equipment, construction equipment, and instruments, leading to declining economic performance overall. Ironically, this slowdown in growth could prompt firms to lay off workers and reduce hiring, exacerbating already high unemployment levels. Refining Legislated Employment Protection How then can CME governments in Europe modify legislated employment protection to enhance commitment, and mitigate lethargy, effects? Simplifying and clarifying dismissal regulations could help in both respects. Critics have charged that

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the rules are currently cryptic, complex, and inaccessible (Bertola, Boeri and Cazes 2000; Eger 2004). If basic, substantive grounds and straight-forward procedures for dismissal were more clearly laid out in the schedules of statutes, employers and employees would have a stronger understanding of their respective rights and obligations and the penalties associated with failure to recognize these. Greater awareness would promote rule compliance by reducing mistakes. Employers would adhere to procedures more readily and refrain more often from firing people they did not have substantive grounds to dismiss (Galdon-Sanchez and Guell 2003), bolstering the commitment effect through increased perceptions of job security, at least among so-called good employees. More employees would work harder to meet minimum performance standards and avoid engaging in misconduct, knowing that not doing so would result, at least eventually, in dismissal. This would help to minimize shirking associated with the lethargy effect. Fewer breaches of the rules would mean fewer potential conflicts and more consistent employee treatment, producing a greater sense of procedural fairness that would help build and maintain trust and confidence, strengthening the commitment effect. Simpler and more overt rules would make court dismissal decisions more predictable. If employers followed the rules, they could more confidently dismiss wrongdoers, poor performers, or redundant workers, knowing that the courts would be unlikely to reverse their decisions (Eger 2004). If employers followed the rules, this would be more obvious to dismissed employees and would dissuade them from appealing dismissal decisions (Galdon-Sanchez and Guell 2003). With these changes, employers would find it easier and cheaper to sack employees for gross misconduct, recurring minor misconduct, and entrenched performance problems. Once again, this would help deter shirking associated with the lethargy effect. Employers would also find it cheaper and easier to use redundancies to cope with a downturn in business conditions, giving them additional numerical flexibility. Governments could cut the costs of dismissal even further by making the process speedier and more informal. For instance, they could make compulsory mediation a precondition of access to adjudication of a dismissal case. They could also use private arbitrators or tribunals rather than courts to adjudicate such cases in the first instance. Appeals could also be limited to errors of law. Some aspects of the law, such as advance notice of redundancy, could even be completely codified and left to labor inspectors to enforce. Governments could simultaneously preserve long-term relations between firms and workers and promote additional numerical flexibility by more lightly regulating overtime and providing short-time, unemployment compensation. Light overtime regulation could mean either lower minimum overtime premiums (e.g., 25%), longer hours of work before qualifying for overtime premiums (e.g., 48 hours), or both. The evidence suggests that this would encourage firms to respond to temporary declines in labor demand by varying average hours of work instead of laying people off (Nunziata 2003). Short-time, unemployment compensation would partially compensate employees, at least temporarily, for any losses of income associated with moving from full- to part-time. In both scenarios, firms would find it

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easier and cheaper to reduce working hours, while preserving long-term relationships with workers so important to developing commitment. Compulsory severance payments, based on years of service, would strengthen the long-term bonds between workers and firms. Such payments would strongly deter firms from engaging in late-career opportunism by making highly paid, long-service workers redundant (Suedekum and Ruehmann 2003). Workers would feel more confident about their long-term prospects for pay raises and promotions, and so more likely to see the relationship with their employer as long-term, thereby supporting commitment. Employment Protection and Flexicurity Some people have advocated so-called flexicurity as an alternative to employment protection. With flexicurity, the government funds and organizes comprehensive, ongoing training and development programs to promote worker employability on the open labor market. Formal employment protection is relatively weak, so the focus is on re-equipping jobless workers to re-enter employment as quickly as possible (van Lieshoudt and Wilthagen 2004). This system is most commonly associated with Denmark and to a lesser extent the Netherlands, but there are some constraints on further dissemination elsewhere (Bredgaardt, Larsen and Madsen 2005). Despite much rhetoric, governments elsewhere in Western Europe have been cautious in adopting the flexicurity model in its entirety, and have been inclined to adopt more modest changes. Any set of regulatory compromises represents the outcome of complex compromises, trade offs, and an element of serendipity. This makes it very difficult to benchmark and replicate institutional features in different contexts (Boyer 2006). Rather than completely transplant flexicurity or any other model, a more fruitful route for policy reform would involve a more incremental process of experimentation, even if, in the end, some aspects of the flexicurity model are adopted. In any event, governments can and have combined institutional features of flexicurity with extensive employment protection. For instance, Sweden retains extensive employment protection and has long used active labor market policies to promote employability. The two policies can be complements rather than substitutes. Conclusions We begin this conclusion with a caution: we share the regulationist view that any form of institutional mediation is necessarily temporarily and spatially specific (Hollingsworth 2006). We acknowledge that high levels of employment protection probably have helped to sustain high value-added production in CMEs, especially in incrementally innovative areas of manufacturing (Asheim and Coenen 2006; Parker 2004; c.f. Thelen 2001). However, this does not mean that the future of such protection is necessarily secure. As has already been noted, what may benefit employers collectively isnt always, or even usually, in their private interests to pursue.

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This certainly applies to employment protection, especially given that employers are under short-term pressure to reduce costs by firing incompetents and making staff redundant. Legislated employment protection is part of the post-war political accommodation of competing class interests. However, any compromise, even a mutually beneficial one like employment protection, is inevitably contested, if a relative rise in one partys power enables it to demand more favorable terms and conditions from the other party (Harcourt and Wood 2003; c.f. Thelen 2001). This is precisely what has happened in the post-1975 era, as power has shifted to employers. Many of the gains won by organized labor in the 1950s and 1960s were lost or eroded in the 1970s, 1980s, 1990s, and 2000s (Harcourt and Wood 2003). Yet, we argue for more limited systematic reforms: employment protection can continue to attract political support, if its strengths are enhanced and its weaknesses are diminished. As Wood (2001, 252) notes, core legal incentives, supported by informal conventions, help reinforce firms reliance on specific institutions associated with a variety of capitalism. This paper has focused on the effects of one such incentive, legislated employment protection, both in helping to define a national way of doing things and in encouraging specific firm level practices. The central conclusion is that employment protection represents one of the main institutional supports to CME capitalism. It provides a sturdy foundation for developing worker commitment to firm goals and strategies. It complements co-determination legislation, requiring consultation and participation in management decisions, in helping to establish production paradigms predicated on incremental innovation. In contrast, lower levels of employment protection in LMEs help reinforce production paradigms based on generic skills and/or more tenuous relations with the workforce. Notes
1. Fordism refers to the mass production/mass consumption paradigm developed and popularized by Henry Ford and his Ford Motor Company. This paradigm was founded on a systemic consistency between mass production and a mass of consumers demanding standardized products (ODoherty 2001, 202). See http://en.wikipedia.org/wiki/Fordism for more details. Taylorist and Taylorism refer to the ideas and practices spawned by Frederick Winslow Taylors 1911 book, The Principles of Scientific Management. More specifically, they encompass the process of redesigning jobs through their fragmentation into the simplest component tasks, reassembling them in a way conducive to a high division of labor, close surveillance, and a linking of immediate output to reward (ODoherty 2001, 182). See http://en.wikipedia.org/wiki/Scientific_management for more details. Standardized for the workers personal characteristics like age and gender. In 2001, George Akerlof was awarded a Nobel prize in economics for his seminal work on adverse selection. See http://nobelprize.org/nobel_prizes/economics/laureates/2001/public.html. The contrary argument is that a no lay offs pledge might attract more loyal, more stable, more serious workers, with more interest in a long-term future with the employer. However, a promise not to fire for poor performance or misconduct still risks attracting lemons.

2.

3. 4. 5.

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