Temporary Contracts and Firms Labour Demand

Transcription

1 Temporary Contracts and Firms Labour Demand Lia Pacelli Universy of Torino and LABORatorio R.Revelli April 2006 Abstract The availabily of a flexible labour force might influence adjustment decisions regarding the rigid part of the labour force. To test this idea, we contrast the use of temporary contracts and permanent ones when a reform made more costly to use temporary workers. The results of our DID analysis indicate that the burden of adjustment shifts on temporary workers if they are present in the firm. If this buffer becomes less available, firms employing temporary workers see their average labour productivy decrease in the short run and their job destruction increase in the medium run: when the shock hs, productivy reacts (and substution between temporary and permanent workers takes place); then as time goes by, the stock of total employment is adjusted and productivy goes back to s previous level. In other words., firms react to shocks adjusting organisation and output on intensive margins in the short run, and more rigid stocks on extensive margins later on. Our results may provide indications on the potential effects of more recent reforms aimed at generating a less costly flexible labour force. JEL: J23, J31 Keywords: temporary contracts, difference in differences, labour demand. Lia Pacelli, Universy of Torino, Dipartimento di Scienze Economiche e Finanziarie, c.so Unione Sovietica 218 bis, Torino, Italy. Tel: , fax: , elm: lia.pacelli@uno. I want to thank O. Attanasio, R. Blundell, B. Contini for their help and advice; the participants to AEA, IZA and LRR conferences for their useful comments on previous versions of this work. Usual disclaimers apply.

2 1. Motivations This work aims at contributing to the analysis of labour demand determinants and constraints in the Italian labour market. It focuses on firing costs imposed by employment protection legislation and on the role they play in the adjustment process of the labour force at the firm level. To estimate the impact of dismissal regulations on labour demand, we focus on the use of on the job training contracts. They are temporary contracts (to be precise they are the only available temporary contract during our observation period) that can be used to hire young workers; their use is supported by the Government, that provides a significant rebate on social secury contributions. Being temporary contracts, they do not generate firing costs when they expire; on the contrary, permanent contracts are expected to generate substantial firing costs when terminated. The availabily of a flexible part of the labour force, i.e. that does not generate firing costs, might influence adjustment decisions regarding the rigid part of the labour force (that does generate firing costs) and might influence overall firm organisation. In particular, we try to answer two questions: Are temporary contracts a buffer to adjust employment? and What are the effects of a more costly buffer on firm performance? The answers are relevant per se, but also in a more general sense. In fact, Italian labour market is known to be highly regulated; nevertheless, there is widespread evidence of high flexibily. Hence becomes important to understand whether instutional constraints are binding on human resources management at the firm level in Italy. This work aims at adding new elements to answer this more general question. The law regulating on the job training contracts changed significantly during our observation period, decreasing the rebate on social secury contributions and imposing eligibily rules for firms, thus restricting the availabily of the flexible part of the labour force. This provides a sort of natural experiment on the impact this event had on human resource management at the firm level. First of all, we test whether the reform actually had a significant impact on the demand for temporary workers in our sample. As we get a posive answer on this point, we address the first question (are temporary contracts a buffer to adjust employment?) both providing descriptive evidence on the fact that temporary workers are more flexible than permanent ones, and testing - using difference in differences analysis - whether temporary workers and permanent ones are substute. We will argue that these two characteristics together identify temporary workers as a likely buffer to adjust the labour force in response to a shock. A different definion of buffer will also be tested, i.e. whether permanent workers are isolated from fluctuations by the availabily of a more flexible part of the labour force. Finally, will be discussed in which sense we can consider flexible, or disposable, a group of temporary workers on which by definion the firm is supposed to invest in training. If the answer to the previous question is posive, as is the case (i.e. according to our estimates, temporary workers actually behave as a buffer to adjust employment), then we can go on and estimate the effect of a more costly buffer on firm performance. We may expect average productivy of labour 2

3 to decrease, because a less flexible labour force is often relatively more distant from s desired level 1. Or we may want to test if, despe the fact that temporary and permanent workers are substute, net job destruction at the firm level is posive, i.e. if total employment decreases because the labour force becomes less flexible. Hence, to answer the second question (what are the effects of a more costly buffer on firm performance?), we test again using difference in differences analysis - whether a more costly buffer is linked to lower job creation and lower average labour productivy. Notice that this is not the same as asking whether an increase in flexibily enhances productivy and job creation; the two effects may not be symmetric. However, our results may provide indications on the potential effects of more recent reforms aimed at generating a less costly flexible labour force. This is important because of the lack of formal evaluation of their effects from the firm point of view, i.e. evaluations focussing on their direct effect on labour demand. In Italy a very small share of the stock of employees works wh a temporary contract; starting from zero in 1984 reached a maximum of about 8% in 1990; this percentage was 5% in 1996 and increased again to 7% in However among them on the job training contracts have been the only available temporary contract till 1993, and in 1996 they still represented about 90% of existing temporary contracts. What matters here is that during our observation period ( ) on the job training contracts and temporary contracts were synonyms. To motivate the assumption that temporary contracts do not generate firing costs when they expire and that permanent contracts do, we can refer to several results existing in the lerature on adjustment costs. In fact, there is empirical evidence of small, if any, adjustment costs involving temporary contracts, and of substantial costs in adjusting the level of permanent employees in continental Europe. For example, Rota (2001) estimates a labour demand model wh fixed and linear adjustment costs using data on permanent contracts in medium-sized manufacturing firms located in the north of Italy (close to an upper bound of labour rigidy in Italy). She finds that fixed firing costs are substantial, around 40% of annual wage costs, and that linear firing costs are less important (3.6% of annual wage costs) 3. Goux et al. (2001) have access to a very rich French dataset where they can actually separate costly and non costly employment changes, i.e. they observe qus, layoffs and retirements as separate events. They estimate - in a convex adjustment cost framework - substantial costs to adjust the level of permanent workers; on the contrary they cannot find significant costs involved in adjusting the number of temporary workers. Aguirregabiria et al. (1999) - in a linear adjustment cost framework - estimates that firing costs are between one third and a half of the gross annual wage of permanent workers in Spain. 1 If we expect that firms have to overcome non convex adjustment costs to change the level of employment, inaction will emerge in their behaviour, and actual and desired level of employment will possibly be different. 2 In 1996 inflows (accessions) using on the job training contracts represent 10% of total accessions and 15% of accessions of young workers (under 30 years of age); the same figures reached a maximum of 16% and 23% respectively in This is consistent wh the importance of collective dismissals and the absence of individual severance payments in the Italian labour market. 3

4 It is worth describing very briefly the Italian instutional framework related to firing costs. Since the early 70s very strong regulations against individual dismissals have been in place. On the other hand, collective and negotiated dismissals - because of lack in demand or the need of reorganising production - are supported by public funds to ease the transion of both the firm and the workers to a better condion. Temporary contracts have not been available for long time and part time jobs were not easily accessible. Over time and up to these days we went through a slow process of reorganisation of the labour market, toward a more flexible setting. Among other reforms, in 1984 on the job training contracts were introduced; over the 90s more collective dismissal tools were brought up; in 1998 temporary contracts and leased work became legal. It must be stressed that medium and large firms were more involved in all this. Very small firms have always been de facto - more able to adjust their labour force through informal channels, and employment protection legislation usually does not apply below the 15 employees threshold. Our data cover both very small and medium sized firms, so we will be able to analyse this aspect from an empirical point of view. If we find that instutional constraints are binding in our dataset of small-medium size firms, we can infer that they are very likely to be binding in larger firms as well. We concentrate on Italy because Italian labour market is an interesting case study. It is commonly considered a highly regulated market; both employment and wages are supposed to be rigid downward and this downward rigidy disincentives firms to increase employment when the business cycle is posive (Bertola (1992), Bentolila and Bertola (1990)). Contrary to this widely accepted idea, some works present evidence of flexibily higher than expected. OECD Employment Outlook (1994) shows that job turnover in Italy is higher than in Germany and comparable to job turnover in the US. Contini et al (1995) present evidence on substantial worker mobily in Italy (yearly separations involve nearly one third of jobs and one fourth of employees). Del Boca and Rota (1998) present a survey of Italian regulations and of their effects on firms labour policy. They show that small firms (less than 16 employees) hire and fire workers much more freely than larger firms; that larger firms use collective (at least 5 employees) temporary or non temporary layoff tools 4 easily and whout administrative impediments. Hence is worth investigating whether this postulated rigidy is real at the firm level and s potential effects on labour demand. A brief foreword about data is necessary, because we use two different dataset in our analysis (different coverage, different un of observation, different time span). We use the first - WHIP - to provide descriptive statistics on the phenomenon as a whole in Italy over a que long period of time; we use the other - the firm dataset - for the econometric analysis as well as for descriptive purposes in the four provinces we study. WHIP (Worker History Italian Panel) uses administrative data drawn from INPS (the Italian Instute for Social Secury) archives and is processed in a public-use file by 4 Ordinary or special supplementation scheme, mobily scheme. 4

5 LABORatorio R. Revelli 5. WHIP is a longudinal dataset reconstructing the working careers of a 1:90 sample of individuals from 1985 to Job records are matched to data on the firm where the job is held, constuting a matched employer-employee database referred to the whole country. The firm dataset has been drawn from the INPS Archive of private firms wh employees, and has been linked to some balance sheet summary statistics 7. The original dataset includes the population of firms in Torino, Parma, Caserta, Taranto. These towns represent different productive areas in Italy. Torino is a large industrial cy in the north west of the Country, wh rising unemployment rate due to declining manufacturing activies. Parma is a small town in the north east, fast growing area wh low unemployment rate. Caserta and Taranto are in the south of Italy, where unemployment rate is high and the economy is weak. It covers the period January December 1992: from the peak of a long posive period toward a sharp economic recession. From the original dataset, we selected a balanced panel of firms employing less than 200 employees. The paper is organised as follows. Section 2 discusses the characteristics of temporary contracts and of their use; section 3 presents the model; section 4 outlines the econometric method; section 5 details the results; section 6 concludes. Full details about the two dataset used are provided in the Appendix. 2. On the job training Contracts The Law On the job training contracts are temporary contracts that can be used to hire young workers; their use is supported by the Government, that provides a significant rebate on social secury contributions. After 1984 Italian employers can hire young workers (15-29 years old 8 ) using this contract. They should provide them wh a formal training program; however, the real investment in training the firm does is neher quantified by the law nor exactly checked by the authories, i.e. there is a posive probabily of cheating on this point. It is a temporary contract that can last up to 24 months. It can be transformed into a permanent one when expires or when is still valid; in the second case the firm retains the rebate provided by the law till the end of the original temporary period. Otherwise, the temporary worker is dismissed at the end of the temporary contract. The law reduces significantly the social secury contributions due on a given wage (in Italy on average social secury contributions amount to 33% of the gross wage). The following scheme presents the characteristics of this contract and the evolution over time of the rebate during the period covered by this study. 5 Full details on the WHIP archive can be found at 6 Although, for a neater presentation, we use up to 1996, i.e. before the introduction of other temporary contracts. 7 It is courtesy of R&P scrl that provided the matched and anonymous dataset years old after June 1991 in some Regions 5

6 year Firms located in the south or defined artisans Firms in the trade / tourism industries employing less than 15 workers All other firms On the job 1990 lump sum (98%) 50 % 50 % training contract lump sum (98%) 40 % 25 % Permanent contract Firms located in the south: full rebate Artisans not in southern regions: no rebate no rebate no rebate It can be seen that southern firms and artisans 9 enjoy a full rebate all-over the observation period; the other firms enjoy a lower rebate, decreased further by the 1991 reform. This should be contrasted wh the characteristics of permanent contract: an open-end contract that provides no rebate on social secury contributions outside the southern regions 10. The saving generated by the use of temporary contracts is a substantial amount: that provided by social secury rebate goes from 8% to almost 33% of yearly wage 11 ; that provided by the absence of firing costs can be up to about 40% of the yearly wage 12 ; i.e. they may sum up to a total of 48% to 73% of the yearly wage. In the north of Italy the incentive to use these contracts is twofold: social secury contributions rebate and no firing costs; in the south the incentive is lower: no firing costs. This is likely to generate a different selection of firms using on the job training contracts in the two areas; we will come back to this point when presenting descriptive evidence on the use of temporary workers and again presenting the econometric results. The law regulating on the job training contracts changed significantly during our observation period, decreasing the rebate on social secury contributions and imposing eligibily rules for firms, thus restricting the availabily of the flexible part of the labour force. In particular, on 1/1/1991 the rebate on temporary workers social secury contributions decreased significantly for a subset of firms, as the scheme above shows. Furthermore, firms that had not hired on a permanent base at least 50% of their temporary workers during the previous 24 months were excluded from the use of this contract (no such constraint existed before 1991). Hence the cost of using this contract increased both in monetary terms and in terms of rigidy or firing costs. In Italy, on aggregate, the effect of the 1991 reform has been massive. Focusing on the dynamic of aggregate employment level of young workers by contract (temporary vs. permanent) over the period we notice what follows (see Figure 1). In 1988, when there was the first change in the law regulating on the job training contracts (they became a b more expensive) we observe some substution between permanent and temporary contracts. In 1991 temporary contracts became much more expensive then before (but still cheaper than permanent ones): we observe a massive substution 9 Legal definion indicating small manufacturing firms where the owner works in the firm. 10 At that time in the south of Italy other laws provided full rebate on social secury contributions for every employee (incumbent or newly hired, regardless the age). These laws changed after From 25% to 98% of SSC, when SSC represent 33% of yearly gross wage. 12 Rota (2001). Of course a collective dismissal would generate lower firing costs per capa. 6

7 from temporary to permanent contracts that lasts a couple of years (temporary contracts can last up to 24 months). Afterwards both groups follow the business cycle. Figure 1: absolute changes in the employment level of young workers (under 30): temporary workers vs. permanent contract holders Figure 2 focuses on the four provinces we analyse and shows that the stock of temporary workers decreased in the areas affected by the reform (Torino, Parma) when the reform came into effect (January 1991), and that was basically constant where the reform did dot change their price (South). In fact in the first two panels of Figure 2 there is a clear break in the series of temporary employees at the end of 1990; their number starts decreasing smoothly as firms wa for the temporary contracts to expire. In contrast to this, the stock of permanent employees, if anything, increased 13 (Figure 3). Figure 2: Number of temporary workers over time Figure 3: Number of permanent workers over time The second constraint (firms that had not hired on a permanent base at least 50% of their temporary workers during the previous 24 months were excluded from the use of this contract) had an obvious impact on the transformation rate (see Table 1). Interestingly, the equilibrium transformation rate, whout any constraint, was about 50%; the constraint made increase by 10 percentage points, but went back to the previous value in a few years. Table 1: Transformation rate from temporary to permanent contract in the same firm (% relative to the stock of temporary workers) Year rate Source: WHIP On aggregate the effect of the reform on the use of temporary contracts is clearly to reduce their use. We also want to be sure that the reform had a statistically significant effect on the behaviour of the firms observed in our dataset. This because they are small and medium size firms, and as we have already argued, very small firms have always been de facto more flexible than the others, despe legal constraints. We formally test this point after presenting the econometric method in the next section. Before doing so we present a descriptive analysis of the characteristics of the firms using these contracts. Who uses temporary contracts? Table 2 shows the number of firms eligible for each discount scheme and in parenthesis the number of firms actually using them (a few exceptions are excluded, because of misclassification). The 50% rebate scheme in 1990 lowers to 40% or 25% after the reform. In our firm dataset the eligible firms are spl almost in half between the two new schemes, and of course they carry on the existing 50%-contracts till 13 This is a balanced panel where entries and exs are excluded; the economic downturn is less sharp in this selected sample. 7

8 they expire. The number of firms using temporary contracts decreases steadily over time, in the group of those affected by the reform. The group of non-affected firms (southern Italy and artisans in the north) behaves que differently after Basically nothing changes among southern firms, but the number of artisans actually using temporary contracts decreases in 1991 and One reason of this different behaviour might be found in the fact that in that area the comparative advantage of temporary contracts could be found only in the absence of firing costs at termination, i.e. was less appealing than in the north of Italy and hence less used. For the same reason users were more selected in the south than in the north and hence they may behave differently. A second reason can be found in the fact that artisans can only be manufacturing firms. In Italy, manufacturing follows a long run declining trend, that is noticeable also in our observation period. We will come back to these points checking the robustness of our results to the exclusion of southern regions from the analysis. Table 2: Number of firms eligible and (actually using temporary workers in December), by class of rebate Caserta (South) Parma (North East) Taranto (South) Torino (North West) Total % users Rebate % 1732 (206) 1716 (553) 1904 (301) 5657 (900) (1960) 17.8% 50% (833) (3133) (3966) 27.4% Total (5926) 23.3% % 1732 (233) 1716 (485) 1904 (290) 5657 (661) (1669) 15.2% 50% n.a. n.a. (110) n.a. n.a. (116) n.a. (226) 40% n.a (62) n.a (364) 7373 (426) 5.8% 25% n.a (256) n.a (1306) 7075 (1562) 21.6% Total (3883) 15.2% % 1732 (198) 1716 (371) 1904 (303) 5657 (595) (1467) 13.3% 50% n.a. n.a. (3) n.a. n.a. (17) n.a. (20) 40% n.a (124) n.a (397) 7342 (521) 7.1% 25% n.a (279) n.a (1345) 7106 (1624) 22.8% Total (3632) 14.3% Source: firm data Transions in the use of temporary contracts are interesting. There is a general decrease in the use of these contracts over time. In the South (Caserta and Taranto), 80% of firms never uses this contract, wh respect to 60% in North East (Parma) and 70% in North West (Torino). This again points to the wider range of supplemented contracts available only in Southern regions. About 10% of firms used these contracts both in 1990 and 1991 in the South; the percentage decreased to 6.4 between 1990 and The same figures are about 20% and 12% in North East; 11.4% and 8.1% in North West. 8

9 Notice that the use of temporary contracts increases as the provided rebate decreases (Table 3). In fact, the law provides the highest rebate to the worst firms, as is targeted to help weaker firms to hire young workers. However, firms in the Northern regions are likely to use temporary contracts more extensively on average, because they are good firms, i.e. more innovative in their internal organisation, more ready and able to use new instruments, more adaptable to a new environment. Furthermore, very small firms do not use temporary contracts very much; their use increases wh firm size (Table 3). This is consistent wh the observation that very small firms are less influenced by employment protection legislation, hence they need to cut firing costs less than larger firms. In fact, for example, gross worker turnover (accessions plus separations over employment stock) of permanent workers in very small firms is about 50% higher than in medium-large firms. Table 3: Percentage of firms actually using temporary contracts in December, by size and rebate class Total Employment at Dec rebate class 98% 50% Total 98% 40% 25% Total 98% 40% 25% Total E< >=E< <=E< <=E< <=E< <=E Total Source: firm data Finally, we performed a simple multivariate analysis to check which firm characteristics are posively or negatively correlated wh the use of temporary workers. We do not intend to estimate any structural model; we also assume different error structures, as a robustness check 15. As expected, the number of temporary workers is increasing wh potential rebate for which the firm is eligible if decides to use temporary contracts 16 ; is decreasing in potential wages the firm has to pay to each worker 17. The number of temporary workers is posively correlated wh the size of the firm, measured by real sales. It increases also wh firm s age and the fact that the firm exports or imports some posive amount (proxies for better qualy firms, given size). It is posively correlated wh the use of self-employees and of overtime (i.e. other flexibily enhancing tools). And is posively correlated wh the 14 The 40% rebate is available for firms in the trade and tourism industry employing less than 15 permanent workers. Hence total employment may be above that threshold. 15 First, we estimated a Tob model on each year in the sample, assuming whe noise errors. Then we pooled the observations and estimated a random effect Tob wh the balanced panel obtained. Finally we estimated a log model wh fixed effects, where the dependent variable is just a dummy on the use of the contract in the firm. The drawback of this last method is that only firms that change status (from users to non-users or viceversa) can be used to estimate. Results available on request % of the real wage in the cell is the social secury contribution; this is multiplied by the available rebate, e.g. 98%, or 50%, or 40%, or 25%. 17 The real wage in the cell the firm belongs to, defined by 13 industries, 3 geographical areas, 3 size classes. 9

10 percentage of whe collars (more technologically advanced firms). It is lower in services than in manufacturing. These results are robust to a partion of the dataset into small and medium-large firms. 3. The models Here we present in turns the models we estimate by difference in differences to answer the questions we are interested in. A few preliminary remarks are needed. First notice that in this paper, to discuss the labour adjustment process we focus on a law whose use is restricted to young workers. Is this choice too liming in order to understand the overall adjustment dynamic in Italy? The absolute changes in aggregate employment level over the last decade give us some insights on the importance of the role young workers play in the adjustment process in this country (see Figure 4). Young people (under 30) bear almost alone the burden of posive and negative changes in total employment. Figure 4: Absolute changes in employment level: all workers vs. young workers (under 30) Notice also that, given the length of our panel of firms we can answer the questions only from a short run point of view. I.e. we cannot identify a long run movement toward a different equilibrium; we can identify a short term reaction to different prices set by the reform. Preliminary to all this, we need to test the effect of the 1991 reform on the use of temporary workers in our dataset, as in previous sections we have only showed s aggregate effect. Hence, first of all we apply the difference in differences method to test whether the 1991 reform had an effect on the demand of temporary workers among the firms in our sample. Had the 1991 reform an effect on the demand of temporary workers? We have already shown that in Italy on aggregate the effect of the 1991 reform has been a massive substution of temporary contracts wh permanent contracts to hire young workers (Figure 1). We have also shown that in two out of the four provinces we are focusing on (the two involved by the reform) the number of temporary workers decreased after December 1990 (Figure 2). Here we want to test formally whether the decrease in demand of temporary workers is statistically significant. We estimate a condional demand schedule for temporary workers at the firm level, as a function of their cost, output and a proxy for the qualy of the firm: l = γ D + X β + u (1) ( l) ( l) ( l) ( l) where l is the number of temporary workers, D is a dummy on those affected by the reform of temporary contracts after the reform took place, X includes a measure of output (real sales) and the share of whe collars as a proxy for the level of complexy of technology used by the firm 18. When the 18 The share of non-production work (whe collars / workforce) can proxy the level of complexy of technology and/or of organisation in the firm. Pacelli et al. (1998) show the link between composion of the workforce by occupation and technology in private Italian firms. For example, if we spl firms by the intensy of innovation observed in the industry they belong to, we have 43% of whe collars in high intensy of innovation sectors and 8% in low intensy of innovation sectors, in the class 1-20 employees; in the class 1000 employees or more these percentages become respectively 51% and 26%. 10

11 cost of temporary workers increases because of the 1991 reform we expect the firm to decrease s demand for them, i.e. we expect γ(l) to be negative. Are temporary contracts a buffer to adjust employment? We infer the answer to this question from two different points of view. First, we test the existence of the characteristics of a buffer. To be a buffer, temporary workers must be more flexible than permanent workers; they must be hired and dismissed more frequently. And, temporary workers must be substute of permanent workers; i.e. if their price increases, demand of permanent workers should go up. Second, and from a different point of view, we test the existence of the expected effect of a buffer: temporary workers should be able to isolate permanent workers from fluctuations of demand, i.e. their presence in the firm should influence not only the number of permanent workers but also their variabily. To answer the question are temporary contracts more flexible than permanent ones? we use some descriptive statistics; the point seems on one side obvious, on the other hand difficult to measure in a convincing way whout a structural model that estimates adjustment costs attached to the two kinds of contracts. We address the question are temporary workers and permanent workers substutes? estimating a permanent contract labour demand equation by difference in differences to single out the effect of the price of temporary workers on the demand of permanent workers. And we apply the same method to gross permanent-contract worker turnover to test if temporary workers significantly isolate permanent-contract workers from fluctuations. However, a maybe more basic question needs to be answered: can temporary workers be used as a buffer by the firm when the firm is supposed to invest in their training? The answer is yes if the investment in training is significantly lower than the saving provided both by social secury rebate and by the absence of firing costs (as we said above, from 8% to almost 33% of yearly wage as social secury rebate, plus up to 40% of yearly wage as deleted firing costs). Given the high amount of saving provided by this contract, we would not be surprised by the fact that firms invest significantly less than that in training. Furthermore, anecdotic evidence points to a large amount of cheating by firms on the training provided to workers hired wh this contract. A further indication in this sense can be provided by transformation rates. Splting the average transformation rate by occupations or by industries defined by their intensy of innovation we observe a higher transformation rate - as expected - in high tech industries wh respect to tradional ones, and among whe collars wh respect to blue collars. This seems an indication of posive correlation between the degree of skill required by the job and the transformation of the temporary contract into a permanent one; the reason can be a higher investment in specific human capal in these cases. However, the spread in transformation rates is about or below 10 percentage points in both cases (50% vs. 60% both by occupation and by industry in 1990), and both high tech firms and whe collars represent a minory in the stock of temporary contracts (about 5% and 11

12 30% respectively). It does not seem likely that the large majory of firms invests heavily in training their temporary workers. Are temporary contracts more flexible than permanent ones? There is some empirical evidence of small, if any, adjustment costs involving temporary contracts, and of substantial costs in adjusting the level of permanent employees in continental Europe. Some descriptive statistics on the relative flexibily of temporary and permanent workers in Italy are available; they are not about adjustment costs directly but about observed flows in and out of the firms; these are strictly correlated to the costs involved, even if they are noisy measures. As temporary contracts are temporary obligations, seems plainly obvious to observe that separation rates are higher for them, even allowing for an average 50% transformation rate at the end of the training period. It may be more convincing to look at accession rates, i.e. total number of accessions (hiring) in year t over the stock of employees at the end of year t 19. Furthermore, as temporary contracts are for young workers only while permanent contracts are for everybody, we focus on accession rates of young workers only. This because job shopping activy at early stages of the working career generates - ceteris paribus - a higher number of accessions among young workers 20. In Table 4 we see that accession rates of temporary workers are twice that of young permanent workers. We may consider this as evidence of lower adjustment costs attached to these temporary contracts in Italy. Table 4: accession rates, Italy , workers under 30 years of age only year temporary contract (l) permanent contract (L) Source: WHIP 19 Notice that using WHIP, transformations of temporary contracts in permanent ones are not defined as accessions (this is not true in the firm dataset). Notice also that accessions are not equal to separations if employment is not in steady state, as is the case here. 20 A final caveat on this basic statistic is about the fact that the number of temporary workers is much lower than the number of permanent workers (600 thousand temporary workers in 1990 and 2866 thousand young permanent workers); hence the statistic accessions over stock is higher also because of this, given the same absolute value of the numerator. Its effect can be noticed in the very first years in the table, just a few years after the introduction of the law (1984). 12

13 Are temporary and permanent workers substutes? We expect temporary workers and permanent workers to be substutes, but not perfect. This would be consistent wh Aguirregabiria et al. (1999), who find that in Spain both level and turnover of permanent contract employees decrease if there are temporary contract workers in the firm, indicating that they are substutes and that the second could represent a buffer against cyclical fluctuations. However in Spain 15 years after they became legal, the equilibrium share of temporary contracts is far from 100%, indicating non perfect substutabily 21. We estimate a condional demand for permanent workers at the firm level 22 L = γ D + X β + u (2) ( L) ( L) ( L) ( L) where L is the number of permanent workers, D is a dummy on those affected by the reform of temporary contracts after the reform took place, X(L) includes permanent workers real wage, a measure of output (real sales), the share of whe collars as a proxy for technology. When the cost of temporary workers increases relatively to the cost of permanent workers we expect the firm to shift toward the use of permanent contracts, if they are substute. I.e. if γ(l) is posive, means that an increase in temporary workers cost of labour (the effect of the reform) triggers a higher demand for permanent workers: the textbook definion of substute factors. As firms have to face hiring costs to adjust the level of permanent workers, if we estimate a significant posive value of γ(l) we can conclude that the effect of the reform was strong enough to overcome hiring costs and actually change the observed level of employment. Are temporary workers able to isolate permanent workers from fluctuations of demand? Another way of deciding whether temporary workers are a buffer to adjust employment is to test whether the fact that they are employed by a firm decreases the variabily of the number of permanent workers employed by the same firm. In this case we test the expected effect of a buffer, while in the previous case we tested the existence of the characteristics of a buffer. The drawback of both proposed methods is that the number of permanent workers and the level of their turnover desired by the firm as an effect of the 1991 reform may be different from the observed level and turnover. The distance between desired and observed values is a posive function of adjustment costs. If the firm wants to increase the number of permanent workers as a reaction to the 1991 reform - has to face hiring costs; if wants to increase permanent contract worker turnover has to face hiring and firing costs. It is clear that the first method proposed suffers less of this problem compared to the second one, as hiring 21 Aguirregabiria et al. (1999) explain this non perfect substutabily by the existence of hiring costs also for temporary contracts. 22 In our labour demand model, capal is kept fixed for simplicy. We focus only on one factor of production, i.e. labour; we analyse the dynamics and interactions among different kinds of labour the firm employs. Of course this is a simplification, justified by the fact that we perform a short run analysis only. However, in the labour productivy model (see below) we will try to control for the investment rate. 13

14 costs are by definion smaller than the sum of hiring and firing costs. I.e. the reform is more easily effective on the level of employment than on s variabily 23. We estimate a reduced form model where gross worker turnover of permanent workers depends on size and qualy of the firm as well as on the availabily of temporary workers: GWTL = γ D + X β + u (3) ( GWTL) ( GWTL) ( GWTL) ( GWTL) where GWTL is the gross worker turnover of permanent workers in the firm (sum of monthly accessions and separations from January to December 24, relative to the stock of permanent workers), D is a dummy on those affected by the reform of temporary contracts after the reform took place, X(GWTL) includes a measure of output (real sales) and the share of whe collars as a proxy for technology. If the reform made temporary workers less available to isolate permanent workers from fluctuations, then after the reform took place GWTL should have increased, i.e. we expect γ(gwtl) to be posive. What are the effects of a more costly buffer on firm performance? If the answer to the previous question is posive, i.e. if temporary workers are a buffer to adjust employment, then we can go on and estimate the effect of a more costly buffer on firm performance. We may suppose that average productivy of labour decreases, because a less flexible labour force is relatively more distant from s desired level. Or we may want to test if, despe the fact that temporary workers and permanent workers are substute, net job destruction at the firm level is posive, i.e. if total employment decreases. To answer these questions, we estimate a productivy equation (4), where average productivy of labour in the firm is a function of the availabily of temporary workers, controlling for wages, investment and the level of technology S E = β (1) (1) (1) (1) γ D + X + u (4) and a condional total labour demand equation (5), as a function of the availabily of temporary workers, controlling for wages, output and the level of technology (2) (2) (2) E = D + X β + γ u (5) (2) We measure the average productivy of labour as average real sales per employee (regardless of the contract). E is the sum of temporary workers and permanent workers. X(1) includes real average wages of employees regardless of the contract, the ratio of durables purchased in the year over sales (a proxy 23 There might be an addional problem. Firms may transform a temporary contract into a permanent one. Unfortunately we do not observe these events in our firm dataset. Hence, when a temporary contract is transformed into a permanent one we observe the stock of temporary workers to decrease by one un and the stock of permanent contracts to increase by one. If the share of temporary workers in the firm is large enough, this may increase artificially the observed GWT of permanent workers. However, the average share of temporary contracts whin a firm is as low as 10%. 14

15 for investment rate), the percentage of whe collars in the firm (a proxy for technology). X(2) includes real average wages of employees regardless of the contract, a measure of output (real sales) and the percentage of whe collars in the firm. D is again a dummy on the reform after the reform took place. As the reform made the buffer labour force more costly and hence less readily available, if γ(1) is negative then means that productivy was depressed by the reform. In the same way, if γ(2) is negative, a less available buffer decreases total employment level, i.e. depresses job creation. 4. Econometric Method We perform a difference in differences analysis to estimate the coefficients of interest (γ) in equations (1) to (5). The reform involved only a subset of firms; hence provides a natural control group made of firms that although they were using temporary contracts were not affected by the reform. As we will explain in details below, we can also estimate the common macroeconomic trend, using the same model wh data on firms that do not use temporary contracts Notice that there is an endogenous selection of firms that decide to use or not to use temporary contracts; however on 1/1/1991 there was an exogenous 25 selection of users that were involved in the reform and users that were not. We will explo this exogenous variabily in the price of temporary workers in the difference in differences analysis. We define four groups of firms: 1. those affected by the reform (firms located in the north of Italy not defined artisans) that were employing temporary workers in 1990 (treatment group g=t) 2. those non affected by the reform (firms located in the south and artisans) that were employing temporary workers in 1990 (control group g=c) 3. those affected by the reform that were not employing temporary workers in 1990 (counterfactual treatment group g=t 0 ) 4. those non affected by the reform that were not employing temporary workers in 1990 (counterfactual control group g=c 0 ) We use two periods: 1990, i.e. before the reform (t=1); 1991 i.e. immediately after the reform (short run effect, t=2). Alternatively we use 1992 to estimate the medium run effect (in this case t=2 is 1992). Wre a generic model y = γ D + X β + u (6) where y is a generic dependent variable, X is a matrix of controls and D is the dummy on the reform: D is equal to 1 iif t=2 (after the reform) and g = T. γ can be estimated using a difference in differences estimator 24 It excludes December to January employment changes to avoid measurement problems generated by legal transformations of firms. In fact, legal transformations usually take place at the end of the Italian fiscal year (31 December). 15

16 γ ~ G y DID s ~ T ~ = y 2 y = E y is T 1 X ~ C ~ y 2 y is C ^ β t = s, g = G 1 and exploing the variabily in prices generated by the 1991 reform. A proper control for observable and unobservable qualy of the firm is crucial to single out the price effect on the quanty of temporary workers used by the firms. The law provides the highest rebate to the worst firms, as is targeted to help weaker firms to hire young workers. However, stronger firms are likely to use temporary contracts more extensively on average, because they are good firms, i.e. more innovative in their internal organisation, more ready and able to use new contracts, more adaptable to a new environment. Furthermore these firms are more likely to be able to hire workers, whatever the contract. Between 1990 and 1991 labour cost of temporary workers increased only for those firms that were already facing the lowest rebate; nothing changed for firms in the south and artisans, that are the most likely to need help to operate. So if we take evidence at s face value we might see that both cost of labour and employment grow in better firms. Of course the qualy of the firm drives the result. The error term u = ψ + k m + ε (8) i i t includes an individual fixed effect, a macro trend that affects individual firms differently and a whe noise. We can make two different assumptions about the expected value of the error term, condional on time, X and the group the firm belongs to. It is standard in this kind of lerature (see Blundell et al., 1998) to impose: [ u t = s i g, X is ] = ψ g kms E, + (9) the condional expectation of the individual fixed effect is constant whin a group and the macroeconomic environment affects everybody in the same way. The first assumption should not be problematic, even if groups are que heterogeneous and only a few observables are available to condion on, as the DID estimator is robust to everything that is constant over time or that grows at a constant rate, even if we do not explicly control for. On the contrary, the second hypothesis may be problematic because the affected and non-affected firms are chosen by the policy maker according to the fact that a group is weaker than the other. It might be that groups defined in this way respond differently to the macroeconomic environment. For this reason we relax the second assumption. A looser and maybe more realistic assumption is to impose that the macro-factor can affect groups differently: [ u t = s i g, X is ] = ψ g kgms E, + (10) (7) 25 Firms may be endogenously selected into industries or locations or size classes, but this is not due to causes related to the use of temporary contracts. I.e. no firm swched to a different industry, for example, between 1990 and 1991 to escape the 16

17 Under the more stringent hypothesis on the errors (equation 9), to estimate γ we apply equation (7); in fact G ~ E y s t = s, g = G = yis X is β = γd + E u, ψ + [ ] ( γ + ψ + km ) ( ψ + km ) [ t = s, i g X is ] = γd + g kms [ ] [( ψ + km ) ( ψ + )] γ DID E γ = T 2 T 1 C 2 C km1 = (12) Under the looser hypothesis on the error structure (equation 10) this does not hold. The consistent way of estimating γ in this case is the following. We estimate the same model (equation 6) using the groups T 0 and C 0. This because, as they do not use temporary workers, they will not show any sign of reaction to the reform. Although users and non-users are self selected, is enough to assume ( k k ) = ( k k ) T to obtain a consistent estimate of γ. In fact, under equation 10: C T 0 C 0 G ~ E y s t = s, g = G = yis X is β = γd + E u, ψ + Using T and C: DID [ ] ( γ + ψ + k m ) ( ψ + k m ) [ t = s, i g X is ] = γd + g kgms [ ] [ ( ψ + k m ) ( ψ + k m )] = + ( k k )( m ) Eγ = γ (14) T T Using T 0 and C 0 we estimate the macro trend: 2 T T 1 C C 2 C C 1 T C 2 m1 DID E[ 0 ] = [( 0 + ψ 2 ) ( 1 )] [( 2 ) ( 1 )] ( )( m T + k 2 1 ) 0 T m ψ k m k m k m k k m 0 T + 0 T ψ 0 C + 0 C ψ 0 C + 0 C = 0 T 0 C 0 and assuming ( k k ) = ( k k ) γ (15) DID DID we have [ γ ] E[ γ ] = γ T C T 0 C 0 (11) (13) (16) E 0 (17) Finally, we need a consistent estimate of beta. To estimate beta we pool the two groups and the two periods and we estimate y = X β + u' by first differences (as we are including individual fixed effects), using IV for the wage if is included among the controls. Then we compute G = n ^ y s yis X is β n for i G, s (18) i= 1 ^ DID T T C C and γ = y y y y (19) As G y s is a random variable, we use s sample variance to estimate the standard error of DID ^ γ. 5. Results of the DID analysis Table 5 shows regressors means. There is a noticeable difference in size (measured by sales or employment) between firms that use temporary workers and have been affected by the reform wh effect of the reform. 17