The impact of uncertainty on two-tiered labor markets

Abstract

This paper studies the impact of higher aggregate 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. Higher uncertainty increases the option value of temporary contracts relative to permanent contracts, changing the composition of the labor force but with minor changes in overall employment levels.