The Effect of Employment Protection on Firms’ Worker Selection

Abstract

To estimate the causal effect of employment protection on firms’ worker selection, we study a policy change that reduced dismissal costs for the employers of more than a tenth of Sweden’s workforce. Our difference‐in‐differences analysis of firms’ hiring uses individual ability measures, including estimated worker fixed effects, GPA at age 15, and military test scores. We find that the reform reduced minimum hire quality by around 2 percent. Our results show that firms both decreased their hiring thresholds and hired more workers. We find that firms increasingly hired young, foreign‐born, and long‐term nonemployed individuals, suggesting potential welfare gains from the reform.