Does dual employment protection affect TFP? Evidence from Spanish manufacturing firms

Abstract

This paper analyzes the effect of having a large gap in firing costs between permanent and temporary workers in a dual labour market on TFP development at the firm level. We propose a simple model showing that, under plausible conditions, both temporary workers’ effort and firms’ temp-to-perm conversion rates decrease when that gap increases. We test this implication by means of a panel of Spanish manufacturing firms from 1991 to 2005, using as natural experiments some labour market reforms entailing substantial changes in this gap. Our main empirical finding is that reforms leading to a lower gap enhanced conversion rates, which in turn increased firms’ TFP, and conversely for reforms that increased the gap.