Evaluating Labor Market Reforms: A General Equilibrium Approach

Job security provisions are commonly invoked to explain the high and persistent European unemployment rates. This belief has led several countries to undertake reforms in the last two decades aimed at reducing firing costs. However, the reduction has typically been applied only to fixed-term contracts, while firing costs for tenured contracts have not been altered. Despite the widespread use of such contracts, there is a lack of quantitative analysis of their impact over the aggregate economy. To fill this gap, we build a general equilibriummodel with heterogeneous agents in a firing-cost economy. We calibrate our model to Spanish data using in part parameters estimated with a dynamic partial equilibrium model and a panel of firm-level observations. Spain is a particularly interesting case since its labor regulations are among the most protective in the OECD and its unemployment rates among the highest. We find that the introduction of temporary contracts has negative effects on aggregate output and employment