The Impact of Uncertainty on Two-Tiered Labor Markets

Abstract

This paper studies the impact of an increase in uncertainty on labor markets where jobs with strong employment protection coexist with temporary contracts. We develop a search and matching model where firms and workers choose the type of contract. The model allows for endogenous separations and job-to-job transitions. We show that in the data, times of heightened uncertainty correlate with a higher share of temporary workers, a lower wage inequality between permanent and temporary jobs, and a slight increase in unemployment. Our model is consistent with these facts. The main mechanism works through the higher relative value of temporary contracts as a result of the higher uncertainty. The change in relative value interacts with the endogenous hiring and firing decisions under both types of contracts.