## Labor’s Liquidity Service and Firing Costs

_IMF Working Papers, May 1, 2007_

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## Bibliographic details
- Authors: Herman Z Bennett
- Published: May 1, 2007
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451866841.001

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### Mechanism: labor’s liquidity service
- When a time gap exists between production and its associated revenues, firing can function as a liquidity adjustment tool that allows firms to increase their short-term liquidity. The paper refers to this feature as "labor's liquidity service."
- The presence of firing costs reduces the value of labor's liquidity service, which affects firms' demand for liquidity and, consequently, firms' demand for inputs.
- Firing costs therefore have effects both at the creation margin (reducing the value of labor as a liquidity buffer) and at the destruction margin (affecting layoffs and exit decisions).

### Model and theoretical predictions
- The paper presents a model that formalizes how firing costs interact with firms' demand for liquidity when production revenues are delayed.
- Prediction: The presence of firing costs has a stronger negative effect on production levels of firms facing liquidity constraints.
- Prediction: Firing costs imply relatively higher destruction (exit or layoffs) for financially restricted firms due to reduced liquidity-adjustment capacity.

### Empirical strategy and evidence
- Regression analysis uses country-industry panel data sets to test the liquidity service effect of firing costs proposed by the model.
- The empirical results reject the hypothesis that the effect of firing costs does not depend on the presence of financial restrictions.
- Evidence shows a relatively stronger negative effect of firing costs on the output of:
  - industries with higher liquidity requirements, and
  - small firms.

### Key findings (bulleted)
- Firing can serve as a liquidity adjustment tool when revenues lag production; this is labeled "labor's liquidity service."
- Firing costs reduce the liquidity service value of labor, lowering firms' demand for liquidity and inputs.
- Financially restricted firms experience relatively higher destruction in the presence of firing costs.
- The negative impact of firing costs on production is stronger for firms facing liquidity constraints.
- Regression evidence across country-industry panels supports the liquidity service mechanism.
- The hypothesis that firing-cost effects are independent of financial restrictions is rejected.
- The negative output effect of firing costs is relatively stronger in industries with higher liquidity requirements and among small firms.

### Policy implications
- Policies that change firing costs can alter firms' liquidity management incentives and therefore affect input demand and output, especially among financially constrained firms.
- Consideration of firms' liquidity requirements is important when designing labor-market regulations: uniform changes in firing costs may have disproportionately large adverse effects on small firms and industries with higher liquidity needs.
- Financial development and access to liquidity could mitigate the negative production impact of firing costs on constrained firms.

*Source: Herman Z Bennett, "Labor’s Liquidity Service and Firing Costs", IMF Working Papers 2007, Issue 120 (Pages: 34), DOI: https://doi.org/10.5089/9781451866841.001*

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/labors-liquidity-service-and-firing-costs-20937_