Labor reallocation effects of furlought schemes: evidence from two recessions in Spain

We examine the impact of furlough schemes in scenarios where aggregate risk has a sector-specific component and workers have sector-specific human capital. In particular, we investigate the distinct responses of the Spanish labor market to the Great Recession and the Great Contagion as both downturns have been triggered by such shocks. However, the COVID-19 episode involves much less job destruction than the previous recession, possibly due to firms’ widespread adoption of furlough schemes (ERTEs) which had been seldom activated earlier. There is consensus that these policies help stabilize the unemployment rate by keeping matches alive in those sectors hardest hit by a crisis. However, under their current design, we argue both empirically and theoretically that ERTEs: (i) crowd out labor hoarding by employers in the absence of those schemes, (ii) increase the volatility of effective working rates and output, and (iii) hinder worker reallocation, especially in short recessions.