Do labor market conditions affect the strictness of employment protection legislation?

We provide a theoretical microfoundation for the inverse relationship between firing costs and labor market tightness and evaluate the effects of this relationship on labor market performance in a matching model à la Mortensen and Pissarides (1994). Results are clear cut and generalize our previous work. First, a sufficient condition to have a firing cost function with a negative slope is when the elasticity of the separation rate with respect to firing costs is equal to one, i.e. when the median voter (which is the employed worker) takes into account in her choice of optimal level of firing costs only the unemployment duration during her lifetime but not the potential gains or losses in terms of wage. Second, the optimal behavior of the economic agents can give rise to a labor market configuration characterized by multiple equilibria: high average duration of unemployment will produce a labor market with low flows and wage and high strictness of employment protection, and vice versa.