This paper studies the effects of the introduction of fixed-term contracts in Spain on the duration distribution of unemployment, with particular emphasis on the changes in duration
dependence. Since the introduction of fixed-term contracts in the mid 1980s, the Spanish labor market has become more dynamic in terms of inflows and outflows from unemployment to employment. I estimate a parametric duration model using cross-sectional data drawn from the Spanish Labor Force Survey from 1980 to 1994, which allows me to analyze the chances of leaving unemployment before and after the introduction of fixed-term contracts. I find evidence that for very short durations, of up to five months, the probability of leaving unemployment has increased since the introduction of fixed-term contracts. But the reverse is true for longer durations. Also, the chances of finding a job are significantly higher for those workers who became unemployed because their fixed-term contract came to an end than for
those who lost their job for other reasons. In addition, there is less duration dependence for
those who lost their job due to the expiration of a fixed-term contract than for those who lost their job for other reasons.

Job security provisions are commonly invoked to explain the high and persistent European
unemployment rates. This belief has led several countries to reform their labor markets and
liberalize the use of fixed-term contracts. Despite how common such contracts have become
after deregulation, there is a lack of quantitative analysis of their impact on the economy. To
fill this gap, we build a general equilibrium model with heterogeneous agents and firing costs
in the tradition of Hopenhayn and Rogerson (1993). We calibrate our model to Spanish data,
choosing in part parameters estimated with firm-level longitudinal data. Spain is particularly
interesting, since its labor regulations are among the most protective in the OECD, and both
its unemployment and its share of fixed-term employment are the highest. We find that fixedterm
contracts increase unemployment, reduce output, and raise productivity. The welfare
effects are ambiguous.

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.