Not long ago I bought a copy of a microecon textbook – Microeconomics (7th ed.) by Robert S. Pindyck and Daniel L. Rubenfeld. I've been leafing through it as a reference. I'm very fond of textbooks in general, and this one is inviting and fun. It's packed with bells and whistles: Definitions in the margins. Thought-provoking example boxes. And full-color printing on every page. Even if there is no reason to use color throughout, the book proudly indicates its polychromatic potential on every page with a tiny version of the book's motif of wildly eccentric interlocking rings that look like a rainbow experiencing a blow-out.
Here is one substantive thing I've found in the book that I thought was pretty funny. In discussing information economics and signaling in job markets, the authors write:
Why don't firms simply hire workers, see how well they work, and then fire those with low productivity? Because this policy is often very costly. In many countries, and in many firms in the United States, it is difficult to fire someone who has been working more than a few months. (The firm may have to show just cause or provide severance pay.)
It's easy to imagine why Pindyck & Rubenfeld might say this. Using basic economic reasoning, you can simply infer that there are substantial legal costs incurred in randomly firing people. That just makes sense.
Yes, but it's wrong.
Firms in the United States enjoy nearly unfettered discretion to fire whomever they choose, whenever they choose, for whatever reason they come up with. Check that — they don't actually need a reason at all. It's called the "at-will employment rule," and it's the law of the land pretty much everywhere in the U.S. (Montana is an exception — kind of.) What that means is that firms generally do not need "to show just cause or provide severance pay," as Pindyck & Rubenfeld posit.
Other countries are certainly different. And in the U.S., the at-will rule does not generally apply to unionized workers, who have collective bargaining agreements that typically impose legal hurdles to facile firing. But the analysis Pindyck & Rubenfeld were using specifically had to do with white collar employees — the kind of employees who are rarely unionized.
Now in the interests of being complete, I should say that it is sometimes possible for employees to allege an implied-in-fact contract or an implied duty of good faith that would serve as the basis for a lawsuit when fired. But those kinds of cases are extremely difficult to win. Let me emphasize: extremely difficult. In the great majority of situations, a worker has absolutely no chance of winning a lawsuit or even of finding a lawyer who will be willing to take the case.
Severance pay, as a general matter, is simply not required by law. Firms might hope that severance pay will head off costly, if ultimately unsuccessful, lawsuits. And no doubt that's true to an extent. But the cost of severance pay is huge compared with the generally tiny legal risk. And the cost of keeping on unproductive workers exceeds the legal costs of firing them to a colossal extent.
What do we make of all this?
The question posed by Pindyck & Rubenfeld suggests that in the absence of legally imposed costs, it would be within the interest of firms to rapidly hire, try out, and fire people. Yet they don't. And if you take a look at the law, you see that legally imposed costs are minimal.
So, why do firms balk at firing people more readily?
The answer is not economics, it's psychology and morality. Bosses don't like firing people. Period. Everybody knows that. The fact is, managers often don't act in the best interests of the firm. They often do not even act in their own best interests. And that is especially the case when it comes to issuing pink slips. Firing people sucks. Managers will generally avoid doing it, and, when they must do it, they will seek ways to make it more pleasant.
That's not a revelation, of course. Non-economists understand this well. What is interesting is to see how economists are so prone to shoehorning an economic explanation into a situation where it doesn't fit.
The impulse is so strong, economists may even perceive legal barriers where they do not, in fact, exist.
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