Temporary employment contracts allowing unrestricted dismissals were introduced in Spain
in 1984 and quickly came to account for most new jobs. As a result, temporary employment
increased from around 10% in the mid-eighties to more than 30% in the early nineties. In
1997, however, the Spanish government attempted to reduce the incidence of temporary
employment by reducing payroll taxes and dismissal costs for permanent contracts. In this
paper, we use individual data from the Spanish Labor Force Survey to estimate the effects of
reduced payroll taxes and dismissal costs on the distribution of employment and worker
flows. We exploit the fact that recent reforms apply only to certain demographic groups to set
up a natural experiment research design that can be used to study the effects of contract
regulations. Our results show that the reduction of payroll taxes and dismissal costs
increased the employment of young workers on permanent contracts. Results for older
workers show insignificant effects. The results suggest a reasonably elastic response of
permanent employment to nonwage labor costs for young workers. We also find positive
effects on the transitions from unemployment and temporary employment into permanent
employment for young and older workers, although the effects for older workers are not
always significant. On the other hand, transitions from permanent employment to nonemployment
increased only for older men, suggesting that the reform had little effect on
dismissals.