Temporary Contracts, Incentives and Unemployment

36 Pages Posted: 29 Nov 2010

See all articles by Maia Güell

Maia Güell

University of Edinburgh

José Vicente Rodríguez Mora

University of Southampton - School of Social Science - Economics Division

Date Written: November 2010


Firing-cost-free temporary contracts were introduced in many European countries during the eigthies in order to fight high unemployment rates. Their rationale was to increase job creation in a context of high firing costs that were politically hard to decrease. Temporary contracts have become a prevalent labor market institution in many countries, and with hindsight it seems uncontroversial that they have failed at decreasing unemployment. Evidence indicates that temporary contracts not only increases unemployment fluctuations, but also unemployment levels. In this paper we argue that the rationale for the introduction of temporary contracts is flawed at its root. We provide a novel explanation of why temporary contracts can increase unemployment even in a context where a reduction of firing costs would actually reduce unemployment. We argue that, if minimum wages are kept at high levels, temporary contracts have an effect not unlike the increase of unemployment benefits. By increasing the flows in and out of unemployment into relatively highly paid temporary jobs (minimum wage), they increase the value of being unemployed. This has a negative effect on incentives, increases wages and reduces the willingness of firms to create employment. We present empirical evidence supportive of some of the implications of the model.

Keywords: firing costs, Fixed-term and permanent contracts, minimum wage, renewal rate, unemployment benefits

JEL Classification: J41, J42, J63

Suggested Citation

Güell, Maia and Rodríguez Mora, José Vicente, Temporary Contracts, Incentives and Unemployment (November 2010). CEPR Discussion Paper No. DP8116, Available at SSRN: https://ssrn.com/abstract=1714888

Maia Güell (Contact Author)

University of Edinburgh ( email )

Old College
South Bridge
Edinburgh, Scotland EH8 9JY
United Kingdom

José Vicente Rodríguez Mora

University of Southampton - School of Social Science - Economics Division ( email )

Southampton, SO17 1BJ
United Kingdom

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