Temporary Contracts, Incentives, and Unemployment

Temporary Contracts, Incentives, and Unemployment

by Maia Guell and Sevi Mora


We provide a novel explanation of why allowing temporary contracts can generate higher unemployment even where reducing firing costs would actually reduce unemployment. We argue that, if minimum wages are kept at high levels, temporary contracts have an effect not unlike that of increased unemployment benefits. By increasing the flows into and out of unemployment into relatively highly paid temporary jobs, they increase the value of being unemployed. This has a negative effect on permanent workersíincentives to work, increases their wages, and reduces the willingness of firms to create employment. We present empirical evidence compatible with the model’s implications.

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