Employment Protection, Employers’ Hiring Strategies and the Screening Role of Temporary Contracts

Abstract

In this paper, we develop a matching model with both permanent and temporary contracts to address situations in which the quality of a match formed by a worker-firm pair is not observable to both workers and firms. The screening and cost-saving aspects of temporary employment contracts are two primary reasons that firms use them, but screening has received little attention in the study of employment protection. We show that increasing dismissal costs decreases job creation and that higher dismissal costs are likely to reduce the hiring threshold for temporary jobs and raise the threshold for permanent jobs. We also examine how changes in dismissal costs affect the average productivity of permanent jobs and discuss the effectiveness of the policy of increasing labour market flexibility by weakening firing restrictions for permanent employment.