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Incentives for indefinite employment
Statements and Comments
Radu VRANCEANU
ESSEC Business School
1.
The principle of “increasing flexibility at the margin” and the
emergence of “dual” labour markets” in South European
countries.
After a long period of disappointing performances in Continental European labour markets, in
1994, the OECD Jobs Strategy called firmly for increasing flexibility as a central element of the
employment enhancing policy. In particular, it was agreed that high employment protection as
delivered by regular open-ended labour contracts, while having an ambiguous effect on total
unemployment, leads to high long term unemployment, and adversely affects productivity, output
and welfare.
In practice, the strategy of reducing dismissal costs relative to open-ended contracts proved to be
hard to implement, due to strong political opposition by the majority of employees and trade
unions. To bypass this difficulty, several governments decided to increase labour market flexibility
at the margin, by creating or extending the category of employees subject to fixed-term contracts,
which firms can fire with small separation costs. As employment protection for the open-ended
contracts was basically kept unchanged, a dual labour market emerged in South European
countries, with highly protected workers covered by open-ended contracts on the one hand, and
much less protected workers, covered by temporary contracts, on the other hand.
In general economists were critical about the welfare implications of these dual labour markets.
They put forward a mixed impact on the global efficiency of the labour market and strong negative
distributional effects (Blanchard and Landier, 2002; Blanchard and Tirole, 2004; Boeri and
Garibaldi, 2005; OECD, 2006).
As pointed out by Luis Toharia in his Discussion Paper, the Spanish experience is representative
of an extreme outcome of the “liberalization at the margin” principle. Subject to very high and
persistent unemployment, Spain began this liberalization process in the mid-eighties, well before
the other countries, by authorizing the widespread recourse to temporary contracts. Hence, in the
late nineties the number of temporary contracts represented more than 30% of total employment
(by far the highest ratio in Europe). In the interval, the unemployment rate declined sharply, to
reach 9.2% in 2005, slightly higher than the EU15 average (of 7.9%).
In the late nineties, the proliferation of fixed-term contracts began to worry Spanish policymakers.
Hence several labour policy reforms were implemented in 1997, 2001, and 2006, with the aim of
providing additional incentives for firms to hire people under open-ended contracts rather than
temporary (fixed-term) contracts, and to convert existing fixed-term contracts into open-ended
contracts. The fiscal incentives for firms to shift to open-ended contracts were accompanied by a
reduction of the protection provided by this type of contracts: severance payments were reduced
from 45 to 33 days per year of employment, but still remain very high according to international
comparisons. The juridical dispute resolution mechanism was also simplified. Luis Toharia points
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out that reforms adopted in 1997 and 2001 do not seem to be very effective in curbing the rise in
fixed-term contracts.
When it comes to evaluate the virtues of such a reform, and the usefulness of transferring it to
other countries, one should firstly proceed to an overall analysis of the macroeconomic
consequences of the full package of Employment Protection Legislation (EPL), including the
protection of regular workers against dismissal, specific requirements for collective dismissal,
regulation of temporary forms of employment, as well as the interaction between the EPL and the
unemployment protection system.
2.
EPL and the performance of the French labour market
2.1
A brief outlook of the French labour market performance
In the last few years, the overall economic performance of the French economy was relatively
positive (growth in France outpaced the EU average, French labour productivity is very high, the
country attracted substantial amounts of FDI, the fiscal position improved, many French
companies are world leaders in their markets). Yet the labour market situation contrasts sharply
with this globally reassuring picture. According to the Eurostat statistical database, in the last ten
years (1996-2005), employment growth in France exceeded 2% only in one year, compared to
Spain where employment growth fell below 2% only in one year. The French unemployment rate
in 2005 was as high as 9.7%.
Quite worrisome, the share of long-term unemployed persons in total unemployment is very high,
equal to 41.2% (as compared to 24,5% in Spain). Another major challenge for the French
policymakers is the rising number of unemployed youth (below 25 years old). Youth
unemployment rate reached 23% in 2005 (compared to 19,7% in Spain and 16.8% in the EU15),
despite the high level of qualification (82.8 percent of the population between 20 and 24 years old
obtained a secondary education degree, compared to 61,3% in Spain, and 74.1 in the EU15).
One usual suspect for this poor performance of the French labour market is the high level of EPL
strictness in France, ranked 6th in 2003 of the 28 countries belonging to the OECD (OECD, 2006).
2.2
Types of labour contracts in France, and the extent of the dual labour market
There are two main types of labour contracts in France: the regular open-ended contract (contrat
à durée indéterminée, or CDI) and the fixed-term contract (contrat à durée déterminée, or CDD).
Temporary help agencies may hire people under special temporary contracts; there is also a
special apprenticeship contract.
When flexibility is interpreted as the ability of the employer to fire an employee at one moment in
time, the overall dismissal cost is the good measure of the protection granted to the employee.
This cost is in general a random variable, because, at the moment when the firm decides to fire a
worker, it does not know whether the worker will sue for abusive dismissal, and if he goes to
court, whether labour judges will sit with the worker or with the firm.
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In general the firm must pay a severance indemnity, depending on the type of contract (CDI or
CDD), the motive of the dismissal, and the decision of the judge.
The French law distinguishes between economic motives, where separation occurs basically
because the firm strives to maintain its competitive edge, and personal motives, because the
worker’s capabilities or behaviour do not match the firm’s needs; one particular personal motive is
the serious professional fault, where the worker commits a serious abuse (in this case, there is no
severance payment). Notice that the law provides no formal definition for the personal motive (the
cause must be “real and serious”), and what can be accepted or not as a valid motive emerged
from juridical practice over time.16 Economic motives are defined in more specific terms, which all
may be related one way or another to the firm’s financial solvency. In addition, firms with over 50
employees cannot fire more than 10 persons if they do not demonstrate before the Labour Public
Authority that they did all they could in order to prevent the dismissals.
Referring to the typical open-ended contract (CDI), severance payments are rather small,
between 1/10th to 1/6th of the monthly wage per year of experience when the dismissal occurs
for personal motives, and the double for economic motives. This severance payment is much
lower than in Spain (33 days per year of experience). Yet the full expected firing cost is much
bigger, since often labour judges rule that the motive is not valid; in this case, they would ask the
firm to pay large severance payment (for unfair dismissal) of at least six months of salary. In
some cases, the judge may rule to reintegrate the employee. The firm must then pay the fine and
the wage over the whole not worked period. In 2004, 26% of the workers fired for a personal
motive went to courts (in general, they dispute the motive of the dismissal). In 64.5% of the
cases, the outcome was favourable to the employees (Munoz-Perez and Severin, 2005). Given
this overall context, in many instances firms try to avoid the trial and agree to pay a negotiated
amount to the employee in exchange for his resignation. This compensation may be quite large,
since the employee’s bargaining threat point is given by the discounted future costs of keeping
him on the payroll.
Given these large implicit firing costs, French open-ended contracts come with a substantial
degree of job protection. Over time, it became more and more difficult to fire someone for
economic motives. Actually, the number of lay-offs for personal motives increased by 40%
between 2001 and 2003 (Lagrenne and Leroux, 2006). Probably firms tend to invoke faked
personal motives, while the true motive is economic (Cahuc and Kramarz, 2004).
The fixed-term contract is also subject to these constrains during its validity period, but the firm
may not renew it at its term without having to justify its decision. It just has to pay a severance
indemnity of 10% of the cumulated compensation. Hence, natural contract termination seems to
be a way to avoid the high dismissal cost specific to open-ended contracts. However, the
recourse to fixed-tem contracts is highly restricted in France. Firms cannot hire temporary
workers for permanent tasks; one person cannot be hired for more than 18th months under such a
contract; if the worker is kept employed after this period, his contract automatically becomes
open-ended. As a consequence, the proportion of workers hired under fixed-term contracts in
France has never reached the substantial amount recorded in Spain. The share of genuine CDD
contracts in the total stock of employment fluctuated between 4% and 6% between 1990 and
2002, and the total share of temporary contracts (CDD, plus interimary and apprenticeship
contracts) never exceeded 12% of total employment (Amira and De Stefano, 2005).
16
See also Blanchard and Tirole (2004), Pigoni and Zuary (2003), Cahuc and Kramarz (2004).
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Given these low ratios, and worried because of the resilience of unemployment despite the
sustained output growth, in 2005 the French government took the rather opposite direction as
compared to Spain, and tried to further enhance the flexibility of the labour market at the margin.
2.3. The new initiatives: “long live the CNE, rest in peace the CPE”
In August 2005, the government created a new form of contract which could be offered by small
size firms (below 20 employees) for new hires, called contrat nouvelle embauche (CNE). The
innovation is that during the first two years, the contract can be cancelled without any justification,
and the decision of the firm cannot be challenged in courts. For every dismissed worker the
employer must pay severance payments of 8% of the gross cumulated compensation, and pay an
additional 2% to the state agency that runs the unemployment benefit system. At the end of the
second year, if not interrupted, the contracts become automatically of the open-ended type. More
than one year later, 10% of the new hires by small firms were signed under the new contract
(Junod et al. 2006).
In the Spring of 2006, the Parliament passed a law that created a similar contract for job seekers
below 25 irrespective of the firms’ size, contrat première embauche (CPE). Student associations
argued that such a law is discriminatory, since it aims at providing the youth with “precarious”
jobs. Many universities went on strike. After one month of strong social unrest, the law was
withdrawn. Probably those who could benefit from the measure were not the university graduates,
but the low skilled young persons. Yet this failed attempt showed once again how difficult it can
be in France to implement measures with specific target groups.
3.
The way ahead: towards the single labour contract
While the idea of liberalizing the labour market at the margin as a way of increasing employment
received a wide political support in France and other countries where the majority of workers is
subject to high protection contracts, many French labour economists express a very sceptical
view on the virtues of such a trend. Building on stylized models of the Continental European
economy (developed in the Mortensen-Pissarides matching framework), they show that such a
measure would lead to excessive polarization between protected and unprotected workers, with
adverse effects on morale, productivity, growth and equity.17
These economists argue that the performance of the labour market would be largely improved if
the existing two types of contracts (CDI – CDD) is replaced by a single type of contract, designed
such as to promote the main goals of labour policy: 18
ƒ Forster employment and reduce the unemployment rate;
ƒ Protect employees against excessive income volatility, in particular by supporting income
during short spells of unemployment;
ƒ Grant firms enough flexibility to adjust to fluctuations in real activity.
17
See Cahuc and Postel Vinay, 2002 ; Cahuc and Carcillo, 2006; L’Haridon and Malherbet, 2006.
18
The main lines of this reform were firstly sketched in a report to the Ministry of Labour by Cahuc and Kramarz
(2004).
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Under such a policy, emphasis is set on income protection and not on job protection. For the new
unified contract, direct firing costs would increase, as firms would be asked to pay a tax for each
dismissed worker. This tax would increase resources of the unemployment benefit system. Such
a tax might help internalizing social costs of unemployment, as required by Blanchard and Tirole
(2004). In turn, the employee could no longer challenge in courts the firm’s decision, except for
outrageous abuses (discrimination, harassment), as is now the case with the CNE. The reform
would thus remove the possibility for judges to second guess the firm’s decision, would eliminate
large trial costs and the uncertainty related to a firm’s decision to fire a worker.19
The idea of the single contract has already caught the attention of the political leaders in France
and might come into the public debate during the Presidential campaign of 2007. Probably the
reform cannot succeed if the majority of insiders get slightly worse-off, even if the global gains are
positive (the unemployed and temporary workers would largely benefit, as well as firms). Hence,
to make the reform politically acceptable, firms should concede some wage increases to workers
under the old open-ended contracts in order to compensate them for the bygone security. The
feasibility of the reform should also be weighed in keeping with cultural barriers in France and the
ability to reform an extremely imbricate Labour Law. One obstacle seems to be the OIT
Convention 158/1982, ratified by France in 1989. This convention, signed in 2006 by 32 countries
(most of them from the developing world), requires that the firing motive should be valid. Yet the
Convention takes a relatively flexible position, since it only defines (art. 5) motives that are not
valid (cannot fire a pregnant women, a worker’s representative, the person who criticize the
hierarchy, ban all forms of discrimination,…). Hence, the single contract may well be consistent
with a loose interpretation of the Convention. Other alternative would be to withdraw from this
agreement, in keeping with the art. 17.
As an upshot of all these, the challenge for both France and Spain, and for the other countries
featuring a dual labour market, is not how to reduce the frequency of fixed-term contracts while
maintaining the excessively high job protection specific to the regular open-ended contract, but
how to make the latter much more flexible, and universal.
19
Austrian experience, as presented by independent expert Helmut Mahringer at this Peer Review, is extremely
instructive.
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References
Amira, Selma and Gilbert De Stefano, 2005, Contrats à durée déterminée, intérim, apprentissage,
contrats aidés, DARES, Premières Syntèses Informations, Avril, 14, 2.
Blanchard, Olivier and Augustin Landier, 2002, The Perverse Effects of Partial Labour Market
Reform: Fixed-term Contracts in France, Economic Journal, 112, pp. F214-F244.
Blanchard, Olivier and Jean Tirole, 2004, Redesigning the Employment Protection System, De
Economist, 152, 1, pp. 1-20.
Boeri, Tito and Pietro Gariabldi, 2005, Two Tier Reforms of Employment Pprotection: a
Honeymoon Effect?, mimeo, Bocconi University, Milan.
Cahuc, Pierre and Stéphane Carcillo, 2006, Que peut-on attendre des contrats nouvelle
embauche et première embauche ?, Revue Francaise d'Economie, 21, pp. 37-86.
Cahuc, Pierre and Francis Kramarz, 2004, De la précarité, à la mobilité: vers une sécurité sociale
professionnelle, Rapport au Ministre d’Etat, Ministre de l’Economie, des Finances et de l’Industrie
et au Ministre de l’Emploi, du Travail et de la Cohésion Sociale,
www.ladocumentationfrancaise.fr/ rapports-publics/ 054000092/index.shtml.
Cahuc, Pierre and Fabien Postel-Vinay, 2002, Temporary Jobs, Employment Protection and
Labor Market Perfomance, Labor Economics, 9, 1, pp. 63-91.
Junod, Bérengère, Christine Lagrenne, Claude Minni, Laure Berne, 2006, Le contrat nouvelles
embauches, DARES, Premières Synthèses Informations, Juin, 25, 4.
Lagrenne, Christine and Marine Le Roux, Les licenciements en 2003, DARES, Premières
Synthèses Informations, Mars, 11, 1.
L’Haridon Olivier and Franck Malherbet, 2006, Employment Protection Reform in Search
Economies, IZA Discussion Paper 2304.
Munoz Perez, Brigitte and Evelyne Severin, 2005, Le droit de travail en perspective contentieuse
1993-2004, Ministère de la Justice, DACS 2005-2, Novembre.
Pigoni, Maria-Theresa and Patrick Zouary, 2003, Les nouveaux usages du licenciement pour
motif personnel, DARES, Premières Synthèses Informations, Juillet, 28, 2.
OECD, 2006, General Policies to Improve Employment Opportunities for All, Chapter 3, OECD
Employment Outlook, 2006, OECD, Paris.
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