The effects of introducing a single open-ended contract in Spain

This paper quantifies the effects of introducing a single open-ended contract for new hires, with increasing severance payments as an alternative to the current situation in Spain, where both temporary and permanent contracts are available. One of the reasons for the excessive job destruction in this economy is the intensive use of temporary contracts. The main driving force behind firm behaviour is the large gap in severance payments between temporary and permanent contracts (8 vs. 45 days of wages per year of seniority). We use a search and matching model to simulate the effects of introducing this new design in severance payments that tries to reduce the duality. We use a search and matching type model of job creation and destruction that is able to generate the main properties of a segmented labour market like the Spanish one. Then, we use this model to simulate the effects of introducing this new design in severance payments. We perform steady-state analysis as well as the transition. Our results show that this contract decreases unemployment (by 21%) and job destruction (which is almost halved in contracts with a tenure of fewer than four years) and tempers both the probability of being fired and tenure distribution as severance payments are reduced. Almost 15% more workers have a tenure of more than 3 years, and there are 23% fewer one-year contracts. The transition shows that the single open-ended contract would be highly beneficial for a majority of workers (only 8% would be jeopardised) because job stability would substantially increase. Firms, would also benefit from a reduction in their expected severance costs by about 9%.