Rota, Paola; (1994) Dynamic Labour Demand: Fixed and Quadratic Adjustment Costs. Doctoral thesis (Ph.D), UCL (University College London).

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Abstract

The thesis focuses on the way recent developments in labour market legislation have affected companies' hiring and firing practices. We consider Italy as a representative example of the effects of regulations on firms' employment decisions. We show that, in Italy, the costs imposed by hiring and firing rules are decreasing rather than increasing at the margin implying large and infrequent changes in employment. We therefore claim that the costs of varying employment are better approximated by a structure in which adjustment costs are fixed, i.e. they are independent of the size of the change in the labour input. This is in contrast with the standard theory of dynamic labour demand in which adjustment is based on strictly convex costs. At a descriptive level, the salient feature of the data, on 3247 companies observed for the period 1982-89 in the Milan area, is a large peak corresponding to zero changes in employment which indicates infrequent changes in employment, as implied by the existence of fixed costs. In order to explain these facts we take two approaches. The first is to consider the presence of the peak at zero as a selection problem to be analyzed in the context of the standard model of dynamic labour demand based on strictly convex quadratic costs. Selection arises from either measurement errors or the presence of fixed costs. The second approach is to consider explicitly fixed costs. In this case, labour demand is governed by threshold rules which guide firms on whether or not to adjust in the face of exogenous shocks. In the presence of idiosyncratic companies, firms' labour demand is therefore characterized by alternate phases of adjustment and non-adjustment. A final theoretical model encompasses both structures of adjustment costs.

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