Opportunistic termination of employment contracts and legal protection against dismissal in Germany and the USA

When analysing labour law most lawyers tend to focus on the protection of existing employment relations and neglect the feedback on ex ante incentives, whereas most economists focus on the incentives to create new jobs without knowing the regulations and relevant court decisions in detail. This paper starts with a simple model that discusses some potential ex post and ex ante effects of protection against dismissal and reconsiders the question of rigidity and flexibility with respect to German and US labour law. Special attention is paid to investments in specific human capital. It is shown that the legal protection against dismissal in Germany is in general characterised by relatively high expected dismissal costs with a low variance, although some court decisions have increased uncertainty for the parties to the employment contract. In the USA legal protection against dismissal is in general characterised by relatively low expected dismissal costs with a high variance, i.e. a high degree of uncertainty. This corresponds to the typical differences in employment relations between Germany and the USA with respect to external mobility, internal flexibility, capital intensity, labour productivity and long-term unemployment.