Moving Towards a Single Labour Contract. Transition vs. Steady State

Juan J. Dolado Etienne Lalé Nawid Siassi (EUI & CEPR) (U. Bristol) (U. Konstanz)

Structural Reforms in the wake of recovery: Where do we stand? Banco de España - Banque de France Research Conference

Motivation

Employment Protection Legislation (EPL) has been rationalized

on several grounds (to):

Correct unbalanced bargaining power in wage negotiations Prevent moral hazard by employers Incentivize employer-sponsored training schemes Provide insurance to risk-averse workers against dismissals

Different aspects of EPL:

Mandatory severance pay Red-tape/judicial/ procedural costs of dismissals Third-party payments (firing taxes, contributions) Regulations restricting use of fixed-term contracts

Dual Labour Markets

Open-ended/perm contracts (PCs) bear stringent mandatory redundancy pay & high red-tape costs

Fixed-term/temp contracts (FTCs) bear much lighter EPL (termination costs) & no red-tape costs

EPL gap leads to a large discontinuity in firing costs → “Revolving door” [workers rotate between TCs and unemployment with low access to PCs]

Negative consequences for unemployment, human capital, and innovation

1 2 3 4 5 6 7 8 9 1005

101520253035404550

Mandatory Severance Pay gap between PC & TC

Years of serviceDay

s of

wag

es p

er y

ear

of

serv

ice

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100

1

2

3

4

5

6

7

8

9

10

Temp-to-perm conversion rate (1999-2010)

Source: Encuesta de Coyuntura Laboral

%

Illustration: Spain as epitome of a Dual LM (pre-2012)

Proportion PC in new contracts

Poor LM performance during the Great Recession has triggered a debate on how to redesign EPL in Dual LM

→ Several proposals

Unified contracts ( keep all FTC) with long entry phases Unified contracts with experience rating (Mutual Fund) Single Open-ended Contract (SOEC) (+ capitalization fund)

Key features of SOEC: (i) open-ended contracts, (ii) lower red-tape costs, (iii) severance pay increases smoothly with tenure

Little is known about desirable profile of SOEC and its effects during transition between EPL regimes + Welfare implications

García-Perez & Osuna (2014)

1 2 3 4 5 6 7 8 9 100

10

20

30

40

50

SOEC 12-36 Dual EPL Years of service

Provides analytical framework for the design of an optimal SOEC (+ entry phase) & its implementation (transition phase) (Benchmark: EPL in Spain pre- 2012)

Extends standard MP S&M model with endogenous job destruction to accommodate the following features:

Insurance role of EPL (relative to UI) when workers are risk averse

Workers differ in liquidity constraints (by age)

Workers differ in job tenure

UI is financed by payroll taxes

Tractability outside steady state (transition phase)

This paper

EPL as insurance device[Lazear (1990), Blanchard & Tirole (2008 ), Pissarides (2010), Cheron et al. (2011) Lalé (2014), etc.]

MP S&M models of Dual EPL [Blanchard & Landier (2002), Cahuc & Postel-Vinay (2002), Kugler & Saint-Paul (2004), Costain et al. (2010) Bentolila et al. (2012), Cahuc et al. (2012), Aguirregabíria & Alonso Borrego (2014), García-Pérez & Osuna (2014), etc.]

Single/ Unified contract proposals[Cahuc & Kramarz (2005), Boeri & Garibaldi (2008), Bentolila & Jansen (2010), Ichino (2014), Conde-Ruiz et al. (2011), Cahuc (2012), etc.]

Related literature

Model

Preliminaries

, > 0

[Castañeda et al. (2003)]

/death

Note: () can be replaced by () where (1- )= red-tape cost

• Workers

• Firms

• New hires

• Ongoing jobs

• Non-employment

Flow equations

• Aggregate

Results

Productivity cut-offs

Wages

Hazard rate of employment (JD)

Steady state welfare comparisons of alternative SOEC+ entry phase

Optimal SOEC

Hazard rate of employment

Average wage - all workers

Benchmark EPL vs. Optimal SOEC

Sensitivity analysis

Transition & Welfare

Transitional dynamics & Welfare analysis

Implementation of SOEC: Non-retroactive reform (only newly-formed matches subject to SOEC) vs. Retroactive reform (all current population subject to SOEC)

Analysis of Transitional Dynamics (SOEC-NR)

Analysis of average welfare gains over transition phase and breakdown of gains by workers and adjustments

Welfare measured in CEU across dual EPL & SOEC regimes

Conclusions

SOEC with 2 years of entry phase and a slope of 5 d.w.y.s.

maximizes steady-state lifetime utility of a newborn worker for the chosen parameterization of the model

SOEC implies allocation gains by removing “ revolving doors” in LM trajectories and thus job turnover at short tenures

Non-retroactive reform: transition towards SOEC entails significant welfare gains for current population, especially for young workers

Retroactive reform implies overall welfare gains but most older workers lose

UI ( -moral hazard) is a more efficient way of ensuring risk-averse workers than EPL

Thanks for your attention