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Credit crunch will mean short-term contracts for new employees

The credit crunch means that companies will be much more likely to offer employees short-term contracts rather than permanent jobs, according to new research.

Dr Vicente Cuñat of LSE and Dr Andrea Caggese of Pompeu Fabra University in Barcelona studied a sample of Italian firms to find out what happens when companies have poor access to credit.

They found that firms that do not have good access to credit markets tend to hire more fixed-term workers and fewer permanent workers. Financing problems not only increase job instability in general, but also they increase the gap between the job stability of fixed-term and permanent workers. In other words, fixed-term workers bear an abnormally high share of the labour adjustments of the firm in downturns, according to the research.

Financial constraints affect firm policies both during upturns and downturns. At the beginning of an upturn, a firm which experiences an increase in current and expected revenues has to decide whether to hire less qualified employees with fixed term contracts, or to try to attract more qualified and skilled individuals by offering permanent contracts.

The advantage of fixed term contracts is their flexibility. The firm can dispose of them at the beginning of a downturn, without having to pay any firing cost.

However, the advantage of permanent contracts is that job stability fosters the investment in specific human capital and leads to a higher productivity.

Dr Cuñat commented:

'All firms face this trade-off; the novelty of this paper is to show that financing constraints tilt the balance towards a higher use of fixed-term contracts. In other words, firms facing difficulties in accessing capital markets place a much higher value in the flexibility of the fixed term workers than firms with no financing problems do."

'At the beginning of a downturn firms unable to access external finance reduce employment much faster than financially unconstrained firms, both because they are forced to cut wages in order to avoid insolvency, and because they employ an higher fraction of fixed term workers, who can be dismissed without cost.

'This effect has important consequence for labour dynamics. The study considers a model economy which replicates the labour market conditions in Italy in the 1990-2000 period, when fixed term workers made up on average only 4% of the total labour force. In this context, the presence of financing constraints increases the volatility of permanent employment contracts by only 6%, while it increases the volatility of fixed term contracts by as much as 35%. As a consequence, the volatility of total employment increases by as much as 16%.'

Dr Cuñat added:

'The implications of our findings are that even a small availability of fixed term contracts may have large consequences for employment dynamics when the firms in an economy are subject to financing difficulties. In this context, policies that aim to reduce the financing constraints face by firms not only would decrease job instability in general, but would also help to close the gap in terms of job instability between fixed-term and permanent contracts.'

To read the paper click here


17 November 2008