Firing cost and firm size: a study of Sri Lanka's severance pay system

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2009-06-01
Authors
Abidoye, Babatunde
Orazem, Peter
Vodopivec, Milan
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Economics

The Department of Economic Science was founded in 1898 to teach economic theory as a truth of industrial life, and was very much concerned with applying economics to business and industry, particularly agriculture. Between 1910 and 1967 it showed the growing influence of other social studies, such as sociology, history, and political science. Today it encompasses the majors of Agricultural Business (preparing for agricultural finance and management), Business Economics, and Economics (for advanced studies in business or economics or for careers in financing, management, insurance, etc).

History
The Department of Economic Science was founded in 1898 under the Division of Industrial Science (later College of Liberal Arts and Sciences); it became co-directed by the Division of Agriculture in 1919. In 1910 it became the Department of Economics and Political Science. In 1913 it became the Department of Applied Economics and Social Science; in 1924 it became the Department of Economics, History, and Sociology; in 1931 it became the Department of Economics and Sociology. In 1967 it became the Department of Economics, and in 2007 it became co-directed by the Colleges of Agriculture and Life Sciences, Liberal Arts and Sciences, and Business.

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1898–present

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  • Department of Economic Science (1898–1910)
  • Department of Economics and Political Science (1910-1913)
  • Department of Applied Economics and Social Science (1913–1924)
  • Department of Economics, History and Sociology (1924–1931)
  • Department of Economics and Sociology (1931–1967)

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Economics
Abstract

Sri Lanka's Termination of Employment of Workmen Act (TEWA) requires that firms with 15 or more employees justify layoffs and provide generous severance pay to displaced workers, with smaller firms being exempted. Although formally subject to TEWA, firms in Export Processing Zones (EPZs) may have been partially exempt from TEWA due to lax enforcement in that sector. A theoretical model shows that firms subject to TEWA will tend to mass at or below the threshold of 14 workers until they get an atypically large productivity shock that would propel them beyond the threshold. EPZ firms will be largely unaffected by the law. In addition, EPZ firms receive preferential tax treatment and exemptions from customs duty. Consequently, firms that anticipate rapid growth will have an incentive to locate in the EPZ sector. We test these predictions using 1995-2003 panel data on the universe of all private, formal sector firms in Sri Lanka. We find that at all sizes, EPZ firms are more likely to add employees than nonEPZ firms. Above the threshold, nonEPZ firms are more likely to shed workers while EPZ firms are more likely to add workers. Once passing the threshold, nonEPZ firms grow faster than nonEPZ firms below the threshold, consistent with a theoretical prediction that only atypically productive nonEPZ firms would cross the threshold. Finally, evidence is consistent with the hypothesis that TEWA restrictions retard the growth of nonEPZ firms below the threshold, but only some of the evidence passes tests of statistical significance. The combined impacts of retarded growth below the threshold, the need for a large productivity shock to cross the threshold, and slower employment growth above the threshold suggest that the TEWA failed to lower unemployment. Instead, it slowed employment growth of nonEPZ firms and induced other firms to seek the EPZ sector in order to evade the law.

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