In light of COVID-19 governments around the globe are juggling between ensuring business liquidity and preserving workplaces. Most countries have taken the approach of increasing regulations and tailoring them to the topicalities.

Yet, such rules pose a risk of turning labor laws into history books rather than universally applicable standards. Could more flexibility in labor relations be of any help both during an economic decline and a normal economic situation? 

A cross-country research report from the Lithuanian Free Market Institute, Dismissal rules and costs: balancing efficiency and employee protection, finds that applicable laws in CEE countries do not provide enough leeway for human capital allocation nor do they create incentives for increasing efficiency of employees, employers and the economy. 

Studies show that more leeway in dismissals may facilitate a more efficient economic recovery. It benefits both employers and employees in the long-term. During the current economic crisis caused by COVID-19 more relaxed dismissal rules and costs would benefit companies that have directly suffered from the lock-down.

More flexible regulations would allow making efficient and timely decisions, saving as many workplaces as possible, adjusting better to economic fluctuations. This in turn would help the economy to recover and create better prospects for more jobs for all. 

Contrary to common belief rigid employee protection rules may harm those who they are designed to protect. This can be said about regulations on severance pays based on tenure, prolonged notice periods based on tenure or belonging to a specific group or restrictions on terminating employment contacts for certain groups of employees.

For example, during the lockdown the majority of employment contracts (65%) in Lithuania were terminated at the will of the employees. This suggests that current employment regulations do not serve the purpose of employee protection. Due to the rigidity of dismissal rules and high costs companies are more prone to select the ground for dismissal not based on the actual intent but based on its cost, which only increases legal uncertainty.

Differentiated dismissal costs and rules may unjustly grant protection to some at the expense of others. For example, if severance pay is differentiated based on tenure, companies might tend to dismiss employees working for a shorter period of time just to save costs.

When dismissal costs are high, employers have fewer incentives to hire new employees or those with questionable qualifications. This increases unemployment and prolonged unemployment.

Expensive and difficult dismissals also contribute to the spread of illegal work, whereas lower dismissal costs and more leeway for the parties to negotiate terms of dismissal encourage legal employment and reduce undeclared work. This means greater employee protection and predictability of the labor market.  

Another issue that is often neglected is the importance of a healthy work climate and how legal regulations may facilitate solving workplace tensions. Many legal systems disregard the overall work environment as a factor determining the efficiency of the employees, the company as a whole and the economy at large. A healthy work environment contributes to the creativity and productivity of employees.

In contrast, when faced with their co-workers’ toxic behavior, people lose productivity and start looking for other jobs. This is not a matter solely of work ethics and management. Toxic behavior has an economic dimension given its effect on productivity and motivation in the workplace. And yet, many legal systems do not facilitate solutions of such HR issues.

Instead, they overregulate the grounds for employee dismissal, leaving companies no choice but to seek legal “gray zones.” In Lithuania, for example, labour law allows a rare practice of dismissing an employee for other than economic reasons with a severance pay of six average monthly wages.

Finally, individual dismissal costs may affect all of the remaining employees when a company is facing economic challenges. Mandatory dismissal requirements that exceed the financial capacity of companies force less well-off companies into economic decline.

As economic fluctuations occur, companies are forced to take out loans not only to maintain a certain level of operations and to cover the salaries of their employees.

As costs of operations accumulate, high dismissal costs lead to greater debts, and so the company’s liquidity decreases. This complicates a swift return back to normal.

Ultimately, rigid rules and high costs may force bankruptcy, which means a loss of jobs and income for the the employees altogether. Rather than having mandatory rules, employers and employees should be allowed to negotiate the terms and costs of dismissals on a case-by-case basis individually or in collective agreements.

Legal systems should facilitate far-sighted decision-making and stipulate long-term universal solutions.  This can best be achieved by providing more leeway for both parties to negotiate the terms of their work relationship and thus bringing laws as close to the needs of market players as possible.  

See Full Study:

Dismissal Rules and Costs: Balancing Efficiency and Employee Protection

The research was conducted in cooperation with partner think-tanks, Center for Economic and Market Analysis (Centra ekonomických a tržních analýz), Czech Republic, Civil Development Forum (Forum Obywatelskiego Rozwoju), Poland, Institute for Market Economics (Институт за пазарна икономика), Bulgaria, and Institute of Economic and Social Studies (Inštitút ekonomických a spoločenských analýz), Slovakia. The research was made possible through the support of a grant from the Rising Tide Foundation. 

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