Asymmetric labour market reforms and wage growth with fixed-term contracts: does learning about match quality matter?

Empirical evidence suggests that fixed-term contracts tend to bear the adjustment cost of asymmetric reforms that increase the employment protection gap between fixed-term and open-ended contracts. However, previous studies did not take into account that fixed-term contracts can play different roles in the labour market and therefore the effect of this type of reform is heterogeneous. We estimate an endogenous regime switching model using rich administrative linked employer-employee data to study the impact of a change in Portuguese employment protection legislation that eased regulations on fixed-term contracts. Our results suggest that the implementation of this reform has a negative impact on match quality, proxied by the probability of conversion of fixed-term contracts. However, the conversion of the contract is associated with a significant increase in wage growth and not all fixed-term contracts are evenly affected by this type of reform. Everything else remaining constant, the wage growth of good matches, i.e. converted fixed-term contracts, was less penalised (-0.16 pp.) than that of non-converted fixed-term contracts (-0.55 pp.) in the years in which the changed legislation was in force. The change in legislation contributed to increase the wage growth differential between both groups in approximately 15%.