From Dual to Unified Employment Protection: Transition and Steady State

Three features of real-life reforms of dual employment protection legislation (EPL) systemsnare particularly hard to study through the lens of standard labour-market search models: (i) the excess job turnover implied by dual EPL, (ii) the non-retroactive nature of EPL reforms, and (iii) the transition dynamics from dual to a unified EPL system. In this paper we develop a computationally tractable model addressing these issues. Our main finding is that the welfare gains of reforming a dual EPL system are sizeable and achieved mostly through a decrease in turnover at short job tenures. This conclusion continues to hold in more general settings featuring wage rigidities, heterogeneity in productivity upon matching, and human capital accumulation. We also find substantial cross-sectional heterogeneity in welfare effects along the transition to a unified EPL scheme. Given that the model is calibrated to data from Spain, often considered as the epitome of a labour market with dual EPL, our results should provide guidance for a wide range of reforms of dual EPL systems.