Federal Reserve Bank of Richmond and

We develop a model of optimal dynamic labor contracts in which firms provide training to workers, but workers cannot credibly commit to stay with the firm. The training is in the form of skills which can profitably be used in other job matches. In the model, wage rates rise with seniority and separation rates are higher for low skilled workers than for high skilled workers. These observations are consistent with the evidence. We show that firing costs (i) increase the average duration of employer-worker matches, (ii) reduce the outside value of the worker, and (iii) increase the level of training provided by the firm. This mechanism has the opposite effect on measured productivity than the selection mechanism of search models with endogenous separation, where firing costs reduce the average quality of active matches. Our model provides a rationale for the positive relationship observed between the level of employment protection and TFP across European countries. †Preliminary and incomplete, comments welcome. Contact Information