This report discusses the Austrian reform of severance pay rules from the point of view of labour economics.
It raises two questions pertinent to severance pay:
- Does severance pay matter?
- Is a reform of severance pay worthwhile?
Does severance pay matter; shoud it be substituted?
Regarding the first question, the following line of argument is presented: severance payments are part of the separation costs, the level of which reflects the prevailing employment protection rules. These protection rules are designed to cover the risks to which an employee is exposed when facing separation from the job. However, this way of risk absorption is, distorting the employers’ decision making on recruitment and separation. A better way to provide cover is to offer (statutory) unemployment insurance. From a welfare point of view, it is even better to enhance re-employability at short notice by labour force activation, by specific qualification programmes for the unemployed, and by life long learning in general.
From severance pat to the separation account
Regarding the second question, it is useful to bear in mind what the Austrian reform consisted of. It was a transition from a »severance pay« to a »separation account« model:
- In the new system, employers pay into a separation account from the first day of employment onwards. In case of a separation the employee can claim the funds of his/her account or transfer them to his/her new employment relationship.
- In the pre-reform model, employers earned their first entitlements not until their employment relationship had lasted for at least three years. The level of severance pay entitlements »jumped« at specific points of employment duration (3, 5, 10, 15 25 years).
The report offers empirical evidence to support an affirmative answer to the second question (»Is a reform of severance pay worthwhile?«):
...on the higt frequency of separation and recruitement from unemployment and from "out f the labour force",...
- Separations are frequent in the Austrian labour market (the annual separation ratio is close to 50%). Thus payments associated with separations matter. Moreover, severance pay tends to depress escape rates from unemployment and from out of labour force; this matters because more than 60% of all recruitments affect people being either unemployed or out of labour force.
...on unfair features of the pre-reform model...
- The pre-reform severance pay system was rather unfair; it excluded those with short spells of (un)employment, who contribute to the flexibility of the Austrian labour market and account for almost 85% of all separations.
...and on the acumulation of liabilities
- - The pre-reform severance pay system trapped small-scale employers who accumulated substantial liabilities (in the form of severance pay entitlements of their employees with long service periods). These liabilities could indeed be the final straw - since the least profitable quarter of all small-scale enterprises have a negative margin on turnover, no return on capital, no capital in their balance sheet, but wage costs amounting to 27% of total cost.
The reform strengthens the flexicurity features
There is another reason why the partners of the reform process (the government, the trade unions, the employers’ associations) considered their efforts worthwhile: The transition to the separation account strengthens the »flexicurity« features of the Austrian employment and labour market policies; and, indeed, when it comes to flexicurity, Austria aims at moving from the average to a frontrunner position among the Member States of the European Union.