Fixed-term Contracts and Unemployment: an Efficiency Wage Analysis

• Authors: Maia Güell.
• BSE Working Paper: 18 | September 15
• Keywords: unemployment , Fixed-term and permanent contracts , renewal rate , efficiency wage
• JEL codes: J41, J42, J63
• unemployment
• Fixed-term and permanent contracts
• renewal rate
• efficiency wage

I analyze the effects of introducing fixed-term contracts, leaving existing labor market regulations unchanged, on unemployment and labor market segmentation. I use an efficiency wage model in which the firm’s choice of contracts and the renewal rate of fixed-term contracts into permanent ones are endogenous. The renewal rate of fixed-term contracts is lower the higher the firing costs of permanent contracts are. Introducing fixed-term contracts can imply higher unemployment even in a world where reducing firing costs would reduce it. Moreover, when the two-tier system does not generate higher employment compared to the system with only permanent contracts, the segmentation of the labor market is socially too large.