Abstract: The theoretical predictions of how employment protection affects firm productivity are ambiguous. In this paper I study the effect of employment protection rules on labor productivity using micro data on Swedish firms. A reform of the employment protection rules in 2001 made it possible for small firms with less than eleven employees to exempt two workers from the seniority rules. I exploit the reform as a natural experiment. My results indicate that increased labor market flexibility increases labor productivity. The increase is not explained by capital intensity or the educational level of workers.

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