Labor market regulations and firm adjustments in skill demand

We study how changes in labor market regulations may trigger firm adjustments in skill demand. Leveraging rich administrative data from Italy, we investigate the effects of a reform that, to increase job stability, reduced the firing costs for permanent employees and tightened the regulation of fixed-term contracts. Using a difference-in-differences (DID) design, we document that the reform had unintended effects, inducing firms to increase layoffs of low-skilled (LS) permanent employees and reduce hires of LS workers on fixed-term contracts. However, the reform had no effect on high-skilled workers or permanent hires. A theoretical search and matching model with heterogeneous skills and contract durations makes sense of our main findings. • Labor market regulations often targets different types of employment contracts. • Labor market regulations may affect firms’ skill demand. • A dual labor market reform in Italy had differential effects by workers’ skills. • It increased firings and reduced hirings of low-skilled temporary workers. • A theoretical model makes sense of our main empirical findings.