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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


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.

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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.

BANCO DE ESPAÑA 9 DOCUMENTO DE TRABAJO N.º 1013


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


Cumulative distribution function

Pro

babi

lity

G(z

)

SPss(z)

STss(z)

RPss

RPss

RTss

RCss

RCssRT

ss


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


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


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


ST1(z)

ST2(z)

SP2(z)

SP1(z)

RP2 RP

1 RT2 RT

1RC

1RC2


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


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


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


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)


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


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


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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