Lessons From The Spanish Route To Labour Market Flexibility

Since the mid-1980s, Spain has gone from a very regulated labour market, with high severance payments and high union bargaining power in wage determination, to a ''dual labour market'', in which permanent employees – around two-thirds of all employees – enjoy the high protection and high bargaining power of the past, while temporary employees – the remaining third – suffer from high turnover rates and low job tenure, and are paid lower wages. Writing in the latest issue of the Economic Journal, Juan Dolado, Carlos Garcia-Serrano and Juan Jimeno explore the lessons of this far from ideal outcome of efforts to improve labour market flexibility.

In 1984, when the unemployment rate was over 20%, the Spanish government liberalised the use of fixed-term employment contracts for regular productive authorities, entailing much lower ''firing costs'' than the ''typical'' permanent employment contract. The proportion of temporary employees in total salaried employment surged very rapidly and has been above 30% since 1990.

Despite further labour market reforms during the 1990s aimed at reducing firing costs for permanent employees and restricting the scope for using fixed-term contracts, the proportion of temporary employment has not significantly decreased. During that period, more than 90% of the new hires were under fixed-term contracts while other types of temporary contacts and the duration of employment spells has very much decreased.

What have been the consequences of the dual labour market that has emerged in Spain? The research shows the following effects of fixed-term contracts:

  • a large increase in worker turnover;
  • a reduction in long-term unemployment;
  • a reduction in specific training offered by firms and a decrease in productivity;
  • a decline in regional migration and in the fertility rate;
  • a widening of the wage distribution, particularly among workers with tertiary education;
  • and a neutral or slightly positive effect (a reduction) on unemployment.

Why has the high level of temporary employment persisted in spite of a series of countervailing reforms to reduce the firing costs of permanent contracts and restrict the use of temporary ones? The research finds contrasting behaviour between the private sector where the share of temporary employment has decreased by about four percentage points and the public sector where the share of temporary employment has increased by about three percentage points.

The hiring practices of the public sector seem to be responsible for this different behaviour and there are at least two explanations for it:

  • First, following fiscal consolidation after the Maastricht Treaty and the further restrictions imposed by the Growth and Stability Pact, there have been so far strict limits to hiring – for every four retirements in the public administration, only one new permanent contract was allowed to be signed.
  • Second, a high proportion of European Union structural funds received by the local and regional administrations for promoting ''active labour market policies'' have been used to hire workers in targeted groups (youths, female workers, the long-term unemployed, etc.) under temporary contracts. To the extent that those contracts help to improve the employability of those disfavoured groups, the still high share of temporary employment may disguise some new favourable effects.

According to this review of the Spanish experience, it cannot be taken for granted that liberalisation of temporary contracts improves the working of the labour market. Together with the plausible benefits of higher ''flexibility'', there may be perverse effects on both efficiency and equity grounds. The most evident effects of the surge of temporary employment are higher worker and job turnover rates, and lower unemployment duration.

As for the unemployment rate, the evidence is more mixed. On the one hand, the lower firing costs associated with fixed-term contracts seem to have contributed to employment growth. On the other hand, there have been some unexpected negative consequences stemming from the existence of a dual labour market: lower investment
in human capital, higher wage pressure, lower labour mobility and a larger wage dispersion.

In fact, a symptom of the mixed blessings of temporary employment is the policy reversals over employment protection legislation that have taken place in Spain since the mid-1990s. Since then, the main goal of reform has been to reduce the share of temporary contracts by cutting firing costs associated with new permanent contracts applicable to targeted groups and subsidising both hires under permanent contracts and the conversion of temporary employment into permanent employment via social security contribution rebates.

''Drawing Lessons from the Boom of Temporary Jobs in Spain'' by Juan Dolado, Carlos Garcia-Serrano and Juan Jimeno is published in the June 2002 issue of the Economic Journal as part of a symposium on temporary work. Dolado is at Universidad Carlos III; his co-authors are at Universidad de Alcala.