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Job Creation and Investment in Imperfect Capital and Labor Markets

This paper shows that liquidity constraints restrict job creation even with flexible labor markets. In a dynamic model of firm investment and demand for labor with imperfect capital markets, represented as a constraint on dividends, and imperfect labor markets, contained in legal firing and hiring costs applicable to some workers, firms use flexible labor contracts to alleviate financial constraints. The optimal policy rules of the theoretical model are integrated into a maximum likelihood procedure to recover the model's behavioral parameters. Data for the estimation come from the CBBE (Balance Sheet data from the Bank of Spain). I evaluate the effects of removing one imperfection at a time, and show that the relaxation of financial constraints produces (i) more job creation than the elimination of labor market rigidities, and (ii) a substantial increase in firm investment, which does not happen if only labor market rigidities are removed.

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Paper provided by Centro de Estudios Andaluces in its series Economic Working Papers at Centro de Estudios Andaluces with number E2004/35.

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Length: 40 pages
Date of creation: 2004
Date of revision:
Handle: RePEc:cea:doctra:e2004_35
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  1. Stephen Nickell & D Nicolitsas, 1995. "How Does Financial Pressure Affect Firms?," CEP Discussion Papers dp0266, Centre for Economic Performance, LSE.
  2. Maia Güell, 2000. "Fixed-Term Contracts and Unemployment: An Efficiency Wage Analysis," CEP Discussion Papers dp0461, Centre for Economic Performance, LSE.
  3. Wasmer, Etienne & Weil, Philippe, 2002. "The Macroeconomics of Labour and Credit Market Imperfections," CEPR Discussion Papers 3334, C.E.P.R. Discussion Papers.
  4. Bentolila, Samuel & Bertola, Giuseppe, 1990. "Firing Costs and Labour Demand: How Bad Is Eurosclerosis?," Review of Economic Studies, Wiley Blackwell, vol. 57(3), pages 381-402, July.
  5. Daron Acemoglu, 2000. "Credit Market Imperfections and Persistent Unemployment," NBER Working Papers 7938, National Bureau of Economic Research, Inc.
  6. Alonso-Borrego, Cesar & Bentolila, Samuel, 1994. "Investment and Q in Spanish Manufacturing Firms," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 56(1), pages 49-65, February.
  7. Victor Aguirregabiria & Cesar Alonso-Borrego, 2009. "Labor contracts and flexibility : evidence from a labor market reform in Spain," Economics Working Papers we091811, Universidad Carlos III, Departamento de Economía.
  8. Bentolila, Samuel & Saint-Paul, Gilles, 1992. "The macroeconomic impact of flexible labor contracts, with an application to Spain," European Economic Review, Elsevier, vol. 36(5), pages 1013-1047, June.
  9. James J. Heckman & Christopher J. Flinn, 1982. "New Methods for Analyzing Structural Models of Labor Force Dynamics," NBER Working Papers 0856, National Bureau of Economic Research, Inc.
  10. Hopenhayn, Hugo & Rogerson, Richard, 1993. "Job Turnover and Policy Evaluation: A General Equilibrium Analysis," Journal of Political Economy, University of Chicago Press, vol. 101(5), pages 915-38, October.
  11. Sharpe, Steven A, 1994. "Financial Market Imperfections, Firm Leverage, and the Cyclicality of Employment," American Economic Review, American Economic Association, vol. 84(4), pages 1060-74, September.
  12. Barlevy, Gadi, 2003. "Credit market frictions and the allocation of resources over the business cycle," Journal of Monetary Economics, Elsevier, vol. 50(8), pages 1795-1818, November.
  13. Cabrales, Antonio & Hopenhayn, Hugo A., 1997. "Labor-market flexibility and aggregate employment volatility," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 46(1), pages 189-228, June.
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