Escaping temporary traps? Evidence from age-based incentives to permanent employment

This paper studies how reducing the cost differential between permanent and temporary contracts affects firms’ use of each contract type. We analyze a 1997 Spanish reform that lowered non-wage labor costs for new open-ended (OE) contracts for workers under 30 and over 45, while leaving short-term (ST) contracts unaffected. Exploiting sectoral exposure and age-based discontinuities, we show that firms substitute strongly from ST to OE contracts for young workers but respond little for older workers. We find partial wage incidence of the subsidy on directly affected permanent jobs. The implied elasticity of substitution between ST and OE contracts is 6.5 for workers below age 30 and close to zero for workers above age 45. We also document that young workers’ wages rise in unsubsidized ST jobs consistent with the expansion of OE employment strengthening their outside options. Overall, the results reveal sharp age asymmetries in contract substitution. They suggest that monetary incentives can facilitate transitions from temporary to permanent employment for young workers, but are less effective for workers above age 45.