Reassessing Labor Market Reforms: Temporary Contracts as a Screening Device

Abstract

Standard models of temporary contracts are either inconclusive, or fail to ac- count for the positive correlation between temporary contracts and the employ- ment rate, and for the high transition rates into permanent employment measured in Europe. This paper shows that a matching model in which rms use temporary contracts to screen workers for permanent positions can successfully ful ll this task. When the model is calibrated to the Italian economy, it accounts for salient statistics including the worker turnover rate, the transition rates into permanent employment, and the drop in the unemployment rate following the reforms im- plemented in the late 1990s. When temporary contracts are used as a screening device, they can increase both productivity and welfare. Their quantitative impact crucially hinges on dismissal costs and minimum wages.