The Use of Flexible Working Contracts in West Germany: Evidence from an Establishment Panel

Abstract

There has been much discussion in Germany whether flexible forms of employment should be facilitated in order to reduce rigidities on the labour market. Flexible labour contracts, such as fixed-term contracts (FTCs), temporary work agency (TWA) employment and freelance work (FL) are, on the one hand, seen as important instruments of adjustment for employers. On the other, they may create a segmented labour market, with part of the workforce being permanently employed in unstable and precarious employment relationships. In West Germany, the share of TWA workers has increased strongly over the last decades. The share of FTC workers has risen, too, although to a somewhat more moderate extent. Some, but certainly not all of this development can be attributed to changes in the law. This paper investigates under which conditions firms employ FTC, TWA or FL workers. The need to use flexible labour contracts arises from the adjustment costs for permanent workers. From the theory of dynamic labour demand, conditions may be derived under which atypical work is a more efficient instrument of adjustment to temporary demand fluctuations than adjustments in the number of regular employees. In addition, by employing atypical workers firms may insulate their regular workforce from changing demand conditions and can therefore reduce firing costs and preserve firm-specific human capital. Using the IABestablishment panel for West-Germany and a probit model which accounts for firm heterogeneity, we find that positive changes in expected or actual sales are associated with a higher probability of employing atypical work, which suggests that these forms of employment are used as means of adjustment.Institutionally, adjustment costs for permanent workers are mainly due to individual and collective dismissal protection and the requirements of German codetermination law. One object of the paper is to assess whether these regulations have an impact on firms' employment decisions. Concerning co-determination, one might argue that the presence of works councils, by making separations more costly, increases the demand for atypical work. In our estimations, this hypothesis is strongly confirmed for FTC employment, although not for TWA or FL workers. Concerning dismissal protection, firms which are too small to be covered by the law should have a lower incentive to use atypical work. In our data set, we have exogenous variation in the minimum number of employees beyond which the dismissal protection law applies. Using this as a source for a natural experiment, we do find that the likelihood of using FTCs decreased for firms which ceased to be covered by the law. Hence, we conclude that legal dismissal protection for regular employees has an impact on the demand for workers on fixed-term contracts.In our estimations, we control for a number of other factors, such as employees' skill levels. Descriptive evidence shows that, on average, FTC and TWA workers possess lower skills than permanent workers. However, the proportion of employees with uni...

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