Firing costs are often blamed for unemployment. This paper investigates this widespread
belief theoretically. The main points are two. First, firing costs are introduced in an effi-
ciency wage model to capture their effects on employment though wages Second, dismissal
conflicts are modeled explicitly and their cost is derived. These two elements are put together
and linked. In this way, the model integrates very different views put forward by different
economists depending on the model used: the view that firing costs reduce employment,
the idea that firing costs are neutral on employment if markets are perfect and complete
and, also the possibility that firing costs are chosen voluntarily by firms. Modeling firing
costs in a context where worker effort is not perfectly observable implies that a double moral
hazard problem could arise. Whenever firms face a redundancy, they tend to use disciplinary
dismissals in order to avoid paying firing costs. Similarly, workers will then tend to deny
any disciplinary case to get a compensation. My claim in this paper is that the resolution
of this problem by a third party will be imperfect given the information problem. This will
in turn imply that disciplinary dismissals will not be costless and therefore firing costs will
have a negative effect on aggregate employment. Some policy implications are discussed.
In particular, it is found that the solution to the problem does not necessarily imply the
elimination of firing costs.

During the 1980s, many European countries introduced fixed-term contracts to fight high
and persistent levels of unemployment. Although these contracts have been widely used,
unemployment remains about the same after fifteen years. This paper builds a theoretical
model to reconcile these facts. I analyze the labor market effect of the introduction of
fixed-term contracts in an efficiency wage model. The form of incentive compatible fixed-
term contracts and the firm’s choice of contracts are studied. Permanent contracts are the
standard way to offer incentives, but fixed-term contracts are cheaper. This generates an
externality, which can make employment higher in the system with only permanent contracts.
As a consequence, from a social point of view, the share of fixed-term contracts is too large.
Increases in the renewal rate of fixed-term contracts into permanent contracts lead to higher
employment levels. The model highlights the interaction between different rigidities in the
labor market. Aggregate employment and the share of temporary contracts are affected in
the same way by firing costs and the flexibility of wages.