Description

During economic crises, firms face a trade-off between labor hoarding—retaining workers de-spite reduced demand—and labor shedding, which can improve efficiency through “creative de-struction.” Employment protection policies, which subsidize labor costs to preserve employment relationships, are often criticized for blocking such efficiency gains. Using administrative mi-crodata from a large-scale policy implemented in Chile during the COVID-19 pandemic—which allowed firms to furlough workers at zero hours while keeping their contracts—we show that such a policy can instead facilitate creative destruction. Firms used the subsidized suspension of contracts to selectively retain and recall higher-ability workers from furlough, while letting lower-ability workers separate. Treated firms subsequently experienced economically significant and persistent productivity gains of around 5–10% over a two-year horizon. The documented pattern of ability-based worker selection provides evidence on a mechanism through which the policy may have contributed to these gains, demonstrating that employment protection policies can simultaneously preserve jobs and promote productivity-enhancing reallocation.