SENIORITY BEFORE HOMOGENEITY: A FIRM'S HIRING AND FIRING DECISION UNDER FIRING COSTS WITH HETEROGENEOUS TENURE

by Pablo Forero

In most labour markets the cost of firing a worker increases with the years of seniority the worker has in the firm. But the heterogeneity of workers in this dimension is often ignored by the literature. But many labour markets, especially dual labour markets, seem to have large and discontinuous jumps in the firing costs with seniority. This can lead to changes in the hiring and firing behavior of firms as they fire workers before the large increase of firing costs, which then affects the seniority structure of the labour market. This paper studies the effects of non-continuous changes in firing costs with respect to seniority and its effects on the labour market. For this I create a partial equilibrium dynamic problem for a firm who can fire its current workers or hire new ones with seniority zero. Each period staying workers increase their seniority by one. I show that small non-continuous changes for firing costs in the seniority dimension can have large effects on the probabilities of being fired before the increase. This creates a labour market similar to dual labour markets. But the overall effects on employment can also be positive for the labour market.