Does employment protection encourage innovation?

The government keeps telling us that workplace rights are holding back economic growth, even though there is precious little evidence to support its claim and a lot of countries with more employment protection than the UK are outperforming us.

But what if the opposite were true? Could it be that, rather than holding business back, employment protection actually improves the way companies operate?

This isn’t as crazy as it might sound. It has long been received wisdom among economists and historians (and received wisdom I happen to agree with) that one of the factors enabling western economies develop so rapidly compared to those elsewhere in the world was the rule of law.

In some societies, the total absence of order meant that there was no point in investing your surplus because it might simply be stolen. At the other extreme, in autocracies, there was no point in setting up a new venture because the king or lord might decide he liked your idea and take it for himself. Only where law applied both to the rulers and the ruled was there protection for those inventing new products and developing businesses. It was because its merchants and entrepreneurs knew that their ventures could not be taken over by the king or stolen by robber barons that industry developed in Europe.

Could something similar be true of organisations? As Gary Hamel told the CIPD conference yesterday, management often stifles innovation. There is a lot of pressure to maintain the status quo in most oganisations. Hierarchies tend to squash creativity. Could protection from arbitrary management work in the same way as protection from arbitrary rulers? Doesn’t employment law offer that little bit of cover to those who speak out?

Challenging the boss or coming up with ideas that threaten powerful interests is risky but at least it’s illegal to sack people for it.  Your boss might shout at you for speaking out of turn or hawking your ‘crazy idea’ around the organization but he can’t fire you for it – at least, not without paying you a lot of money and having to explain to his peers why he’s doing it. Does employment protection provide the safety net that makes people more willing to challenge and take risks?

This paper from America’s National Bureau of Economic Research suggests that it might. By limiting employers’ power to act against employees, the authors say, employment law enhances employees’ innovative efforts and increase the likelihood of firms investing in “mould-breaking projects.”

To demonstrate this, they compared US states with employment protection to those without it. Allowing for other variables, they found a strong correlation between innovation and the presence of employment protection. The numbers of patents filed and the amounts invested in R&D were higher in states with employment protection and, furthermore, both increased after employment laws were enacted.

They concluded that laws limiting employment-at-will (or hire-and-fire) encourage employees to take risks, leading to more innovation. Laws against unfair dismissal thus lead to more innovative firms:

Laws affecting employment and dismissal are an important part of the policy toolkit for promoting innovation and possibly economic growth.

OK, a study of a few thousand firms in one country isn’t conclusive but the USA is the OECD country with the lowest level of employment protection at national level. That makes it an ideal laboratory for such comparisons. It’s the hire-and-fire states with no employment rights that score less well on measures of innovation.

And innovation is one of the major factors behind economic growth. It may well be, then, that, far from holding the economy back, employment protection is creating safe havens for new ideas. In which case, scrapping it is the last thing we should be doing.

Hat Tip: Chris Dillow for the link to the research.

Update: Some later research by the same team found similar results across four countries – U.S., U.K., France, and Germany. They concluded again that “firm-level innovation is causally determined by laws governing the ease with which firms can dismiss their employees.”

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4 Responses to Does employment protection encourage innovation?

  1. Jackart says:

    I think this could also mean employment protection is concentrated where it isn’t damaging: high skilled workers in creative industries. These workers have the most agency, and employment rights make it harder for the employee to walk so work in the employers favour. These businesses are concentrated in a few states. In red states, with more manufacturing and blue-collar work, pressure from china, not low employment rights is the main reason for economic underperformance. Cum Hoc Ergo Propter Hoc.

    The idea that ‘nice stuff is free’ is tempting to believe, but the case is very much not proven.

  2. Pingback: Does employment protection encourage innovation? - Rick - Member Blogs - HR Blogs - HR Space from Personnel Today and Xpert HR

  3. The key relationship is employment rights -> risk -> innovation -> growth. If you accept that growth is a desirable goal, and that innovation is a better guarantee of this than just working harder, then you should implement policies that encourage (thoughtful) risk-taking. It is paradoxical that advocates of the magical properties of small businesses and startups do not follow the logic of this and campaign for a ctizens’ basic income. Instead, they are usually to be found demanding weaker employment rights and preferential treatment such as employer NIC holidays. It’s almost as if they’re trying to grow profits, in the face of inadequate innovation, through rent-seeking and wage repression.

  4. Duncan Brown says:

    The research is interesting, but has limits. They use a measure of innovation which favours ‘big’ innovation rather than the everyday stuff that effects most organisations; so it only proves so much. (And, I know, they’re using the data that are available; this is a general problem in innovation research.)

    Plus, the law may have positive innovation effects alongside negative employment effects; the two are clearly compatible. The choice here though (re your rule of law point) is not between order and chaos, but between different arrangements of rights and responsibilities, which we have to choose between on the basis of their relative costs and benefits.

    Those costs and benefits will differ in different settings; as Jackart says, in the federal US, it therefore explains why states will differ in their attitude to the laws. Over here, we have to set one law for all. As you (Rick) were talking about the boring stuff the other day, you’ll appreciate that in a lot of industries a marginal gain to innovation might not be worth the reduced employment flexibility.

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