Waiting for the Prince Charming: Fixed-Term Contracts as Stopgaps

Overview & Synopsis

In this paper, I build a simple Mortensen-Pissarides model embedding a dual labor market. I derive conditions for the existence of an equilibrium with coexisting strongly protected open-ended contracts and exogeneously short fixed-term contracts. I also study dynamics after a reform on employment protection legislation. Temporary contracts play the role of fillers while permanent contracts are used to lock up high-productivity matches. High firing costs favor the emergence of a dual equilibrium. Employment protection legislation encourages the resort to temporary employment in job creation. This scheme is intertwined with a general-equilibrium e_ect: permanent contracts represent the bulk of employed workers and a more stringent employment protection reduces aggregate job destruction. This pushes down unemployment and in turn reduces job creation ows through temporary contracts. The model is calibrated to match the French labor market. Policy experiments demonstrate that there is no joint gain in employment and social welfare through reforms on firing costs around the baseline economy. The optimal policy consists in implementing a unique open-ended contract with a strong cut in firing costs. Increases in firing costs within a dual labor market lead to a sluggish adjustment, while large cuts in firing costs lead to a quick one. The adjustment time of the labor market is highly non-monotonous between these two extremes. Policy-related uncertainty significantly strengthens fixed-term employment on behalf of open-ended employment. Considering extensions, I draw conclusions on the inability of a large class of random-matching models to mimic the distribution of temporary contracts' duration while maintaining possible the expiring temporary contracts' conversion into permanent contracts.