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EMPLOYMENT FLUCTUATIONS IN A DUAL LABOR MARKET
James Costain, Juan F. Jimeno and Carlos Thomas
Documentos de Trabajo N.º 1013
2010
EMPLOYMENT FLUCTUATIONS IN A DUAL LABOR MARKET
EMPLOYMENT FLUCTUATIONS IN A DUAL LABOR MARKET
James Costain, Juan F. Jimeno and Carlos Thomas
BANCO DE ESPAÑA
Documentos de Trabajo. N.º 1013
2010
The Working Paper Series seeks to disseminate original research in economics and fi nance. All papers have been anonymously refereed. By publishing these papers, the Banco de España aims to contribute to economic analysis and, in particular, to knowledge of the Spanish economy and its international environment.
The opinions and analyses in the Working Paper Series are the responsibility of the authors and, therefore, do not necessarily coincide with those of the Banco de España or the Eurosystem.
The Banco de España disseminates its main reports and most of its publications via the INTERNET at the following website: http://www.bde.es.
Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged.
© BANCO DE ESPAÑA, Madrid, 2010
ISSN: 0213-2710 (print)ISSN: 1579-8666 (on line)Depósito legal: M. 19682-2010 Unidad de Publicaciones, Banco de España
Abstract
In light of the huge cross-country differences in job losses during the recent crisis, we study
how labor market duality – meaning the coexistence of “temporary” contracts with low fi ring
costs and “permanent” contracts with high fi ring costs – affects labor market volatility. In
a model of job creation and destruction based on Mortensen and Pissarides (1994), we
show that a labor market with these two contract types is more volatile than an otherwise-
identical economy with a single contract type. Calibrating our model to Spain, we fi nd that
unemployment fl uctuates 21% more under duality than it would in a unifi ed economy with
the same average fi ring cost, and 33% more than it would in a unifi ed economy with the
same average unemployment rate.
In our setup, employment grows gradually in booms, due to matching frictions, whereas
the onset of a recession causes a burst of fi ring of “fragile” low-productivity jobs. Unlike
permanent jobs, some newly-created temporary jobs are already near the fi ring margin,
which makes temporary jobs more likely to be fragile and means they play a disproportionate
role in employment fl uctuations. Unifying the labor market makes all jobs behave more
like the permanent component of the dual economy, and therefore decreases volatility.
Unfortunately, it also raises unemployment; to avoid this, unifi cation must be accompanied
by a decrease in the average level of fi ring costs. Finally, we confi rm that factors like
unemployment benefi ts and wage rigidity also have a large, interacting effect on labor
market volatility; in particular, higher unemployment benefi ts increase the impact of duality
on volatility.
Keywords: Firing costs, temporary jobs, unemployment volatility, matching model,
endogenous separation.
JEL classifi cation: E32, J42, J63, J64, J65.
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0.95 1 1.05 1.1 1.15 1.20
1
2
3
4
5
6
7
8
9
10
Match productivity z
Surplus functionsS
urpl
us
0.95 1 1.05 1.1 1.15 1.20
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
Match productivity z
Cumulative distribution function
Pro
babi
lity
G(z
)
SPss(z)
STss(z)
RPss
RPss
RTss
RCss
RCssRT
ss
BANCO DE ESPAÑA 30 DOCUMENTO DE TRABAJO N.º 1013
2 2.5 3 3.5 4 4.50.08
0.09
0.1
0.11
F
Une
mpl
oym
ent
2 2.5 3 3.5 4 4.50.26
0.27
0.28
0.29
0.3
F
Tem
p em
ploy
men
t
2 2.5 3 3.5 4 4.5
0.58
0.6
0.62
0.64
F
Per
m e
mpl
oym
ent
2 2.5 3 3.5 4 4.50.4
0.45
0.5
0.55
0.6
F
G(R
T ss)
2 2.5 3 3.5 4 4.50.7
0.75
0.8
0.85
0.9
F
G(R
C ss)
2 2.5 3 3.5 4 4.50.1
0.2
0.3
0.4
0.5
F
G(R
P ss)
2 2.5 3 3.5 4 4.50.36
0.37
0.38
0.39
0.4
F
q( ss
)
2 2.5 3 3.5 4 4.50.12
0.14
0.16
0.18
F
Job
findi
ng ra
te
2 2.5 3 3.5 4 4.50.01
0.015
0.02
0.025
F
Pro
mot
ion
rate
2 2.5 3 3.5 4 4.50.03
0.035
0.04
0.045
FTem
p se
para
tion
rate
2 2.5 3 3.5 4 4.54
6
8
10x 10-3
FPer
m s
epar
atio
n ra
te
2 2.5 3 3.5 4 4.51.05
1.1
1.15
FAve
rage
pro
duct
ivity
low baseline high
BANCO DE ESPAÑA 31 DOCUMENTO DE TRABAJO N.º 1013
15 20 25 30 350.08
0.09
0.1
0.11
1/
Une
mpl
oym
ent
15 20 25 30 350.2
0.25
0.3
0.35
0.4
1/
Tem
p em
ploy
men
t
15 20 25 30 350.5
0.55
0.6
0.65
0.7
1/
Per
m e
mpl
oym
ent
15 20 25 30 350.4
0.45
0.5
0.55
0.6
1/
G(R
T ss)
15 20 25 30 350.76
0.77
0.78
0.79
0.8
1/
G(R
C ss)
15 20 25 30 350.2
0.25
0.3
0.35
0.4
1/
G(R
P ss)
15 20 25 30 350.36
0.37
0.38
0.39
1/
q( ss
)
15 20 25 30 35
0.15
0.16
0.17
1/
Job
findi
ng ra
te
15 20 25 30 350.01
0.015
0.02
0.025
1/
Pro
mot
ion
rate
15 20 25 30 350.025
0.03
0.035
0.04
0.045
1/Tem
p se
para
tion
rate
15 20 25 30 357
8
9
10x 10-3
1/Per
m s
epar
atio
n ra
te
15 20 25 30 351.08
1.1
1.12
1.14
1/Ave
rage
pro
duct
ivity
low baseline high
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0.95 1 1.05 1.1 1.15 1.20
1
2
3
4
5
6
7
8
9
10S
urpl
usSurplus functions, N=2, large F
Match productivity z
ST1(z)
ST2(z)
SP2(z)
SP1(z)
RP2 RP
1 RT2 RT
1RC
1RC2
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0 2 4 6 8 10 12 14 16 18 20-4
-3.5
-3
-2.5
-2
-1.5
-1
-0.5
0
0.5
1
quarters
% o
f lab
or fo
rce
0 2 4 6 8 10 12 14 16 18 20-0.5
0
0.5
1
1.5
2
2.5
3
3.5
4
quarters
% o
f lab
or fo
rce
0 2 4 6 8 10 12 14 16 18 20-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
quarters
% o
f lab
or fo
rce
0 2 4 6 8 10 12 14 16 18 20-0.25
-0.2
-0.15
-0.1
-0.05
0
quarters
% o
f lab
or fo
rce
unemploymentvacancies
permanent jobstemporary jobs
job creationpromotions
destruction of temporary jobsdestruction of permanent jobs
BANCO DE ESPAÑA 43 DOCUMENTO DE TRABAJO N.º 1013
0 2 4 6 8 10 12 14 16 18 20-1
0
1
2
3
4
5
6
7
quarters
% o
f lab
or fo
rce
0 2 4 6 8 10 12 14 16 18 20-5
-4
-3
-2
-1
0
1
quarters
% o
f lab
or fo
rce
0 2 4 6 8 10 12 14 16 18 20-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
1.2
1.4
quarters
% o
f lab
or fo
rce
0 2 4 6 8 10 12 14 16 18 20-0.5
0
0.5
1
1.5
2
2.5
3
3.5
4
quarters
% o
f lab
or fo
rce
unemploymentvacancies
permanent jobstemporary jobs
job creationpromotions
destruction of temporary jobsdestruction of permanent jobs
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0 20 40 60 80 100 120 140 160 180 200-6
-4
-2
0
2
4
Quarters
% o
f lab
or fo
rce
Employment stocks
0 20 40 60 80 100 120 140 160 180 2000
1
2
3
4
5
Quarters
% o
f lab
or fo
rce
Employment flows
0 20 40 60 80 100 120 140 160 180 200-1
-0.5
0
0.5
1
Quarters
% d
evia
tion
from
mea
n
Log of average productivity
Perm jobsTemp jobs
Job creationTemp destructionPerm destructionRecession beginsExpansion begins
Perm productivityTemp productivityAverage productivity
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0 2 4 6 8 10 12 14 16 18 200
0.5
1
1.5
2
2.5
3
3.5
4
quarters
% o
f lab
or fo
rce
Stocks of "fragile" jobs in a boom
fragile permanent jobsfragile temporary jobsfragile jobs (single contract)
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0 20 40 60 80 100 120 140 160 180 200-4
-3
-2
-1
0
1
2
Quarters
% o
f lab
or fo
rce
Employment stock
0 20 40 60 80 100 120 140 160 180 2000
1
2
3
4
5
6
7
Quarters
% o
f lab
or fo
rce
Employment flows
0 20 40 60 80 100 120 140 160 180 200-0.3
-0.2
-0.1
0
0.1
0.2
0.3
0.4
Quarters
% d
evia
tion
from
mea
n
Log of average productivity
Employment
Job destructionJob creationRecession beginsExpansion begins
Average productivity
BANCO DE ESPAÑA 52 DOCUMENTO DE TRABAJO N.º 1013
0 0.5 1 1.5 2 2.5
0.7
0.8
0.9
1
1.1
1.2
Firing costs in single contract
Std
dev
of u
nem
ploy
men
t (%
of l
abor
forc
e)
Volatility of the single contract as function of firing costs
Sameunemployment
Sametotal F
SameF as perm
Sameaverage F
Volatilityof dualmarket
BANCO DE ESPAÑA 53 DOCUMENTO DE TRABAJO N.º 1013
0 0.5 1 1.5 2 2.50.4
0.45
0.5
0.55
0.6
0.65
0.7
0.75
0.8
Firing costs in single contract
Std
dev
of u
nem
ploy
men
t (%
of l
abor
forc
e)
Volatility of the single contract as function of firing costs
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