This paper analyzes the macroeconomic effects of employment protection legislation (EPL) through workers' optimal human capital choices and the resulting changes in labor market fluidity. In a general equilibrium model, stringent EPL shifts investment from general to firmspecific human capital, reducing aggregate labor mobility across employers. Using Japanese microdata to discipline the model's human capital accumulation process, we show that although EPL increases overall human capital accumulation, the resulting decline in labor market fluidity lowers average matching efficiency and generates sizable output losses following structural changes that require labor reallocation.
Keywords: Labor market fluidity; Human capital; Employment protection; Job tenure
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.