By Normann Rion
http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-02331887&r=dge
In this paper, I build a simple Mortensen-Pissarides model embedding a dual labor market. I derive conditions for the existence of an equilibrium with coexisting strongly protected open-ended contracts and exogeneously short fixed-term contracts. I also study dynamics after a reform on employment protection legislation. Temporary contracts play the role of fillers while permanent contracts are used to lock up high-productivity matches. High firing costs favor the emergence of a dual equilibrium. Employment protection legislation encourages the resort to temporary employment in job creation. This scheme is intertwined with a general-equilibrium effect: permanent contracts represent the bulk of employed workers and a more stringent employment protection reduces aggregate job destruction. This pushes down unemployment and in turn reduces job creation ows through temporary contracts. The model is calibrated to match the French labor market. Policy experiments demonstrate that there is no joint gain in employment and social welfare through reforms on firing costs around the baseline economy. The optimal policy consists in implementing a unique open-ended contract with a strong cut in firing costs. Increases in firing costs within a dual labor market lead to a sluggish adjustment, while large cuts in firing costs lead to a quick one. The adjustment time of the labor market is highly non-monotonous between these two extremes. Policy-related uncertainty significantly strengthens fixed-term employment on behalf of open-ended employment. Considering extensions, I draw conclusions on the inability of a large class of random-matching models to mimic the distribution of temporary contracts’ duration while maintaining possible the expiring temporary contracts’ conversion into permanent contracts.
This is a very cool paper that highlights one of the major ills of the French labor market and what to do about it. However, as the paper nicely demonstrates, the transition dynamics are important. In particular, some reforms involve a temporary increase in unemployment, and we all now how difficult transitions work out in France.
NEP-DGE Blog 
Thank you very much for these very nice comments. In this paper, I tried to implemented the simplest extension of the classic Mortensen-Pissarides model which can embed both fixed-term and open-ended contracts. In the resulting model, fixed-term contracts serve as waiting stations, whereas open-ended contracts are lockers. When the meeting firm-worker pair’s quality is high, the best choice is too lock up the match through an open-ended contract which includes a firing cost. If the meeting firm-worker pair’s quality is intermediate, the stakeholders face a trade-off between going back to searching for a high-quality match or producing immediately. The fixed-term contract strikes a bargain between these two possibilities. Despite its triviality, the model is able to produce complex steady-state outcomes and dynamics to a change in institutions summed up in firing costs here. The main reason for this is the interaction of the latter mechanism and a general-equilibrium effect. The main lesson from this paper is that reforming a dual labor market implies high political costs in terms of transitions as well as steady-state values. In the case of the model, the parameters are known and it’s possible to reach a given target. In real life, it is not the case. Consequently, statut quo may be preferrable to a reform with unpredictable – and possibly disastrous – outcomes