The liberalization of fixed term contracts in Europe has led to a two tier regime, with a growing share of jobs covered by temporary contracts. The paper proposes a matching model with direct search in which temporary and permanent jobs coexist in a long run equilibrium. When temporary contracts are allowed, firms are willing to open permanent jobs in as much as their job filling rate is faster than that of temporary jobs. From the labour demand standpoint, a simple trade-off emerges between an ex-ante job filling rate and ex-post flexible dismissal rate. From the labor supply standpoint, a trade-off emerges between an ex-ante lower job finding rate and ex-post larger retention rate. The model features a natural sorting of firms and workers into permanent and temporary jobs. It is also consistent with the observation that workers hired on a permanent contract receive more training. The paper shows that the transition from a rigid to a two a tier regime system is always associated with a transitory fall in unemployment.
