Productivity Growth

   Efficiency gains resulting from more flexible and competitive labor markets have been another important reason why the United States was able to benefit from recent shifts in technology. The United States ranks first among G7 countries in the World Bank's Rigidity of Employment Index, indicating very flexible labor markets relative to other G7 countries. Japan, for example, ranks fourth among G7 countries, while France ranks last. The index averages measures of the difficulty of hiring a new worker, restrictions on expanding or contracting the number of working hours, and the difficulty and expense of dismissing a worker. While other countries are tied with the United States on the latter two measures, the United States owes its first place rank to the ease with which American employers can hire new employees.

   Flexible labor markets allow workers to flow to high-productivity and highwage industries. Hiring and severance costs tend to increase unemployment by making firms reluctant to hire new workers. They encourage labor hoarding, a practice in which firms hold on to workers not currently needed for production in order to avoid the costs of hiring new workers when the firm's workforce needs to expand. Labor hoarding lowers the level of productivity and reduces the average growth rate of productivity, as firms find it more difficult to respond to innovations and shifts in demand.

   Flexible labor markets improve productivity growth because they allow firms to more easily adjust the size and scope of their operations in response to economic developments. For example, after an increase in efficiency, a firm may become more competitive and decide to expand output and so need to hire more workers. The firm may also wish to change the mix of workers it employs. Flexible labor markets allow these transitions to occur at a low cost.