Abstract

Firing-cost-free temporary contracts were introduced in Europe during the 1980s in order to ght unemployment in a context of high firing costs that were politically hard to decrease. Since then, they have become a prevalent labor market institution in many countries. Yet evidence indicates that these contracts have not been successful at bringing down unemployment levels. In this paper we argue that the rational for the introduction of temporary contracts is awed at its root. We provide a novel explanation of why allowing temporary contracts can generate higher unemployment even in a context where a reduction of firing costs would actually reduce unemployment. We argue that, if minimum wages are kept at high levels, temporary contracts have an e¤ect not unlike an increase of unemployment benefits. By increasing the ows in and out of unemployment into relatively highly paid temporary jobs (minimum wage), they increase the value of being unemployed. This has a negative e¤ect on the incentives to work for permanent workers, increases their wages and reduces the willingness of fi rms to create employment. We present empirical evidence compatible with the main implications of the model.