February 22, 2011

The Difference In Workers’ Contracts Is One Of The Main Causes Of Unemployment

The main conclusion of this study, in which UC3M Economics Department professor Juan J. Dolado has participated, is that one of the main factors explaining the growth in the unemployment rate in our country is the large difference that exists between the severance pay received by employees with permanent contracts and those with temporary contracts. Specifically, the situations in Spain and France are compared. The two countries share apparently similar labor institutions (job protection legislation, unemployment benefits, collective bargaining, etc.) and had almost identical unemployment rates (approximately 8 per cent) just before the current economic crisis began. However, whereas the unemployment rate in France has only reached 10 per cent, the rate in Spain has gone up to 20 per cent. Why have unemployment levels in the two countries differed so greatly during this Great Recession? To answer this question, the researchers have used a strategy similar to the one used in the clinical trials of medicines: they have analyzed the response of two patients with similar characteristics (Spain and France), who share the same disease (the effects of the crisis spread like a virus), and who have received different treatments (the differences in labor regulations).

This research concludes that the difference between the protection offered by permanent and temporary contracts is the most important difference in labor regulations in the two countries and that, on its own, it explains a large part of the greater increase in unemployment in Spain. "After developing an equilibrium search and matching model in the labor market with both types of contract, calibrating it so that it would produce a series of key variables in the labor markets of the two countries before and after the Great Recession, we have shown that the only appreciable difference in the labor institutions is that the gap is 50 percent higher in Spain than it is in France, even though the average cost of a lay-off is similar. Simulating what would have happened in Spain during the recession if France's smaller difference had been in place, we found that the unemployment rate would have increased 45 per cent less than it has since 2008", explains Professor Juan J. Dolado, one of the research study's authors, together with Samuel Bentolila, of the Centro de Estudios Monetarios y Financieros (CEMFI)(Center for Monetary and Finance Studies), Pierre Cahuc and Thomas Le Barbanchon, of the Ec³le Polytechnique (Polytechnic School) of France; the study was published in a discussion article by the Centre for Economic Policy Research (CEPR).

In the literature regarding the effects of lay-off costs it is clear that facilitating labor flexibility by means of temporary contracts has an ambiguous effect on unemployment, since it increases both the creation and the destruction of jobs. However, a novel result that this study highlights is that if the difference in protection guaranteed to permanent employees and temporary employees is great enough, the negative effect of job destruction predominates in the average of expansive and recessive phases. The explanation for this is that the bigger the gap, the lower the proportion of temporary jobs that will become permanent, since the costs of lay-offs involving the latter type of contract induce companies to use a sequence of temporary contracts, especially if there are hardly restrictions on their use, rather than converting them to long term contracts. The high turnover rate for these contracts translates into a higher average unemployment rate. "Besides", adds Prof. Dolado, "a much more lax regulation of the use of temporary contracts and the rigidity of permanent contracts discourage companies from investing in sectors with high added value and, in contrast, foment specialization in sectors with low added value, such as residential construction, which has been one of the most affected by the crisis". These results indicate that the indirect effects of the gap in job protection on the disproportionate weight of this sector, together with the enormous rate of turnover in temporary workers, are responsible for almost half of the ten percentage points more that separate Spain's unemployment rate from France's. The rest can be explained by other reasons, such as the greater growth of the working population, the greater weight of the residential sector in tourist areas, etc.

Single contract

These differences in workers' protection based on whether a contract is permanent or temporary lead to a labor market that is divided and segmented, which turns out to be harmful in terms of the level and volatility of the unemployment rate, according to the results of this study. Because of this, the study's authors advocate the elimination of the majority of temporary contracts and the introduction of a single type of permanent contract with a severance pay that increases with the years spent in the job, as was proposed in the Manifiesto de los 100 (http://www.crisis09.es/propuesta/?page_id=37). The objective is to reduce the tremendous volatility of employment and the high average rate of unemployment in the future.

This research has been selected as one of eight finalists for the Premio Vanguardia de la Ciencia (Science Vanguard Prize), created by the Grupo God³ (God³ Group) in collaboration with the Obra Social de CatalunyaCaixa (Caixa Catalunya Social Projects) to promote excellence in research and to find the best scientific contributions from Spanish research centers during 2010 (http://www.lavanguardia.es/vanguardia-de-la-ciencia). This initiative is inspired by the example of Science magazine which, each December, designates an "Advancement of the Year" to recognize the most important scientific research carried out during the previous twelve months.


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