Employment fluctuations in a dual labour market

James Costain, Juan F Jimeno and Carlos Thomas

Economic Bulletin, 2010, issue APR, No 04, 129-137

Abstract: During the last two decades, the Spanish labour market has shown high employment and unemployment volatility. In growth phases, job creation and the decrease in the unemployment rate have been very high but during downturns in the cycle, job destruction and the increase in unemployment have also been substantial. This phenomenon has become yet more evident during the recent economic crisis when the unemployment rate, in the face of a slowdown in growth similar to that experienced by other countries, increased by around 10 pp, a far higher figure than that recorded even in countries which have labour markets with low fi ring costs (for example, Ireland and the United States). In principle, there may be several explanations for this high employment volatility. In the face of a negative shock, a sectoral breakdown biased towards labour-intensive activities may trigger more pronounced job destruction. Furthermore, the greater wage inertia is, with labour costs not adapting to this shock, the greater job destruction will be. Finally, the level and duality of fi ring costs directly impact hiring and fi ring decisions and, consequently, they also determine net job destruction in the face of a negative shock. This article summarises the main findings of a recent eminently analytical paper [see Costain, Jimeno and Thomas (2010)], the main objective of which is to identify to what extent the third of these above-mentioned factors, duality, generated by the coexistence of very different temporary and permanent employment contracts, contributes to increasing employment and unemployment volatility. In order to achieve this aim, it is necessary to analyse firms’ decisions to make temporary employees permanent ones and to hire and fi re both types of employees, so as to calculate the effects of different economic shocks on job creation and destruction flows and to compare them with the flows that would be recorded in a labour market with a single contract type. The main findings of this analysis suggest, firstly, that contract duality exacerbates fluctuations in employment and unemployment. If the social costs of unemployment tend to grow more quickly the higher the level of unemployment is, this greater volatility has obvious costs in terms of social welfare. Similarly, contract duality tends to reduce productivity, even without taking into account the negative effects associated with a lower accumulation of experience and smaller investment in training by employees and employers which creates even more temporary employment. These effects cannot be recorded by the analytical model used. Lastly, for the lower volatility that would result from moving away from duality to also translate into a reduction in the average unemployment rate, it would have to be coupled with a reduction in average fi ring costs. In any event, it is important to take into account that the analytical model, the results of which are summarised in this article, is not per se designed to act as a basis for a comprehensive proposal for labour reform. In order to draw up a proposal of this type it would be necessary to analyse, for example, other important factors within the regulatory framework of employment contracts and additional aspects on how the labour market operates, such as wage bargaining mechanisms and the management of active policies to boost employment which may influence the reduction in the unemployment rate over the cycle and its volatility. All of these matters are clearly beyond the scope of this article.

Date: 2010
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