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We build a small open economy, real business cycle model with labor market frictions to evaluate the role of employment protection in shaping business cycles in emerging economies. The model features matching frictions and an endogenous selection effect by which inefficient jobs are destroyed in recessions. In a quantitative version of the model calibrated to the Mexican economy we find that reducing separation costs to a level consistent with developed economies would reduce output volatility by 15 percent. We also use the model to analyze the Mexican crisis episode of 2008 and conclude that an economy with lower separation costs would have experienced a smaller drop in output and in measured total factor productivity with no significant change in aggregate employment.

Job security --- Labor market --- Business cycles --- Economic cycles --- Economic fluctuations --- Cycles --- Employees --- Market, Labor --- Supply and demand for labor --- Markets --- Employment protection --- Employment security --- Job insecurity --- Security, Job --- Economic security --- Personnel management --- Layoff systems --- Econometric models. --- Supply and demand --- Labor --- Macroeconomics --- Production and Operations Management --- Employment --- Unemployment --- Wages --- Intergenerational Income Distribution --- Aggregate Human Capital --- Aggregate Labor Productivity --- Business Fluctuations --- International Business Cycles --- Unemployment Insurance --- Severance Pay --- Plant Closings --- Labor Economics: General --- Production --- Cost --- Capital and Total Factor Productivity --- Capacity --- Macroeconomics: Production --- Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data) --- Labour --- income economics --- Economic growth --- Total factor productivity --- Productivity --- Industrial productivity --- Labor economics --- Economic theory --- Mexico

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We build a partial equilibrium model of firm dynamics under exchange rate uncertainty. Firms face idiosyncratic productivity shocks and observe the current level of the real exchange rate each period. Given their current level of capital stock, firms make their export decisions and choose how much to invest. Investment is financed through one period loans from foreign lenders. The interest rate charged by each lender is set to satisfy an expected zero-profit condition. The model delivers a distribution of firms over productivity, capital stocks and debt portfolios, as well as an exit rule. We calibrate the model using data from a panel of Mexican firms, from 1989 to 2000, and analyze the effect of the 1994 crisis on these variables. As a result of the real exchange rate depreciation, the model predicts: (i) an increase in the debt burden, (ii) an increase in exports, and (iii) a large decline in investment. These real effects are consistent with the evidence for the Mexican crisis.