Spain: Selected Issues

This Selected Issues paper analyzes the sources of the persistence of geographical unemployment imbalances and low speed of adjustment to regional labor demand shocks in Spain. The paper argues that, under present labor market arrangements, these imbalances are unlikely to be corrected in the near future. In particular, the current wage bargaining system appears to be excessively centralized and to result in nationally set wages that are too high to reduce unemployment in high-unemployment areas. The paper also analyzes the May 1997 labor market reform.


This Selected Issues paper analyzes the sources of the persistence of geographical unemployment imbalances and low speed of adjustment to regional labor demand shocks in Spain. The paper argues that, under present labor market arrangements, these imbalances are unlikely to be corrected in the near future. In particular, the current wage bargaining system appears to be excessively centralized and to result in nationally set wages that are too high to reduce unemployment in high-unemployment areas. The paper also analyzes the May 1997 labor market reform.

II. A Note on the May 1997 Labor Market Reform25

63. Spain’s Achilles’ heel remains its labor market. The unemployment rate stood at 21 percent—the highest among industrial countries—in 1997. Moreover, 34 percent of wage earners—a far larger proportion than in any other European country—are currently under temporary contracts with a duration of no more than three years (Table 6 and Figure 6).26 These workers have little job security, and entrepreneurs have few incentives to train them. Following an agreement between trade unions and employers’ associations, the government introduced a labor market reform package in May 1997, which aims to reduce Spain’s high unemployment rate and its large share of temporary employment.

Table 6.

Spain: International Comparisons of Dismissal Costs, the Share of Temporary Wage Earners, and Minimum Wage Regulations

article image
Sources: Instituto Nacional de Estadistica; OECD, Employment Outlook; CEOE; Tableau de Bord, European Commission; Dolado et al. (Economic Policy, 1996); and staff estimates

The definition of temporary contracts is identical for some, but not all countries.

In countries where there is no statutory minimum wage, refers to minimum wages set as part of collective agreements in relevant sectors.

No binding provisions; covered by collective agreements

Figure 6.
Figure 6.

Spain: Temporary and Permanent Wage Earners, 1987-97

Citation: IMF Staff Country Reports 1998, 053; 10.5089/9781451812015.002.A002

Source: Bank of Spain.

64. The thrust of this labor market reform is to reduce effective dismissal costs, which are high by international standards. The main methods are a clarification of the causes for “justified” dismissals, which carry lower costs, and the establishment of a new type of permanent contract with lower dismissal costs. Accompanying measures are intended to promote the use of the new permanent contracts and to restrict somewhat the use of temporary contracts. The purpose of this chapter is to review the main characteristics of the reform. To help assess its usefulness, the next section briefly compares a number of key features of Spain’s labor market with those of other countries. The chapter ends with a description of recent indicators on labor market performance, even though it is too early to provide a full evaluation of the effectiveness of the reform.

A. Brief International Comparison of Labor Market Arrangements

65. Although it is difficult to assess the precise extent to which labor market policies and arrangements are responsible for Spain’s high unemployment rate and its large share of temporary employment, it may be useful to compare three key features of the Spanish labor market with those of other countries. First, Spain stands out among industrial countries, including European countries, with respect to high dismissal costs. Average dismissal costs amounted to three times the already high EU average in 1995. Statutory dismissal costs for “unjustified” dismissals (the norm in Spain) were two and a half times the EU average prior to the reform.27 Such high dismissal costs may well help explain the relatively large share of temporary employment in Spain (Table 6).

66. Second, unemployment compensation in Spain is not significantly more generous than in other EU countries, though this is not to say that the European average is necessarily a desirable target. While the gross replacement rate is somewhat higher than average, the net replacement rate is slightly below average, especially for the long-term unemployed (Table 7). At the same time, incentives to search for a job may be relatively low for Spanish workers who have been dismissed after a long tenure because they collect not only unemployment benefits, but also very generous dismissal compensation. Third, minimum wages are relatively low in Spain by international standards. In sum, it seems that high dismissal costs are the labor market feature with respect to which Spain is furthest from industrial country averages. Not surprisingly, their reduction has been the main focus of the May 1997 reform.

Table 7.

Spain: International Comparisons of Replacement Rates

article image
Source: OECD, Employment Outlook.

B. Dismissal Costs Prior to the May 1997 Reform

67. For permanent contracts signed before May 1997, the cost of dismissals undertaken for economic, technical, organizational, or production-related causes depends on whether the labor courts judge them to be justified or unjustified. Compensation amounts to 20 days per year worked (with a maximum of 12 months) for justified dismissals, and 45 days per year worked (with a maximum of 42 months) for unjustified dismissals. Dismissal compensation in justified cases is not out of line with the EU average, but that in unjustified cases far exceeds it, as shown above. The courts judge that dismissals are unjustified in almost three fourths of cases.

68. Therefore, the main reason that average dismissal costs are high in Spain may be that the definition of justified dismissals is not sufficiently clear. This shortcoming was already recognized in the 1994 labor market reform, which attempted to clarify and expand the possible reasons for justified dismissals by including organizational and production-related causes.28 Nevertheless, that change in definition proved to be insufficient to alter the courts’ behavior significantly. In fact, in the first half of 1997, 70.9 percent of the dismissal cases ruled upon by the courts resulted in decisions at least partially in favor of the worker, a proportion only marginally lower than that observed in 1993 (72.8 percent).

C. Main Points of the May 1997 Reform

69. The May 1997 reform recognizes the need to reduce effective dismissal costs. In an attempt to do so, it introduces a further clarification of the reasons for justified dismissals, which would in itself render the reform successful if it led to a significant reduction in the share of dismissals that are deemed unjustified. However, in light of the uncertainty surrounding the impact of that clarification, the reform includes other measures, the most important of which is the introduction of a new type of permanent contract that carries lower dismissal costs.

70. The reform consists of a number of new measures and modifications of existing legislation, which are listed in order of potential importance.

• Clarification of the reasons for justified dismissals. The text of the reasons for justified dismissals for technical, organizational, or production causes was modified as follows:29

Old text: “to guarantee the future viability of the firm and of its workforce through a better organization of its resources.”

New text: “to better organize resources in order to overcome difficulties that impede the firm’s well-functioning, whether related to its competitive position in the market or to demand requirements.”

Although this change in text is usually described as a clarification, it expands somewhat the range of reasons for justified dismissals, to include cases where firms are not doomed to future bankruptcy in the absence of job cuts, but may be facing difficulties of a more temporary nature. At the same time, it remains uncertain whether this change will lead to an increase in the share of dismissals that are deemed justified, because the burden of proof remains on the employer, and the new definition still seems to allow ample room for interpretation by the courts.

• Establishment of a new permanent contract available to groups of people who have encountered particular difficulty finding permanent jobs: (i) unemployed persons between the ages of 18 and 29, or above 45; (ii) persons who have been unemployed for more than a year; (iii) persons who are handicapped; and (iv) workers who are currently employed under a temporary contract. The cost of unjustified dismissals under the new contract will be 33 days per year worked (with a maximum of 24 months), compared with 45 days per year worked (with a maximum of 42 months) for the existing permanent contracts, which are unaffected.30 Therefore, statutory dismissal costs remain well above the EU average on both existing permanent contracts and the new type of permanent contract (Table 6).

• Introduction of fiscal incentives designed to encourage the use of the new permanent contracts. Entrepreneurs’ social security contributions will be reduced for the first two years of the contract by 40 percent for new permanent hires of workers below age 29 or long-term unemployed and by 50 percent in the case of conversions of temporary, apprenticeship, and training contracts into permanent contracts. In the case of new permanent hires or conversion of temporary contracts for unemployed workers above age 45, handicapped workers, or women in certain sectors where they are underrepresented, the reductions will amount to 60 percent for the first two years and 50 percent thereafter, with additional incentives for the hiring of handicapped workers. Moreover, owners of small and medium-sized firms will receive incentives in the form of lower personal income taxes (IRPF). In fact, for the purpose of IRPF calculations, these firms (whose revenues are usually imputed on the basis of indicators such as the number of employees and the area of the establishment) will not be required to report workers who are hired under the new permanent contracts, for the first two years of the contract.31

The government estimated that the yearly cost of all these incentives would be about Ptas 100 billion (0.1 percent of GDP), under the assumption of 200,000 new permanent contracts of this type a year. Savings of Ptas 16 billion would result from the elimination of existing incentives to temporary contracts. There is no indication of savings elsewhere, though some might result from the decrease in unemployment.

• Substitution of a new training contract for the unpopular apprenticeship contract, which was eliminated. The most notable change is the reduction in the maximum age for eligible workers from 25 years to 21 years. Other differences seem to be relatively small: the maximum duration of the apprenticeship contract is reduced from three years to two years, but may still be extended to three years through collective agreement;32 the minimum and maximum duration of the contract (six months and three years, respectively) will be enforced more strictly than in the past; entrepreneurs who do not provide the minimum amount of formal training under the contract will be charged with fraud; benefits will now be provided to trainees in case of temporary inability to work; for workers above 18 years of age, in some cases salaries will be slightly higher as a proportion of the minimum salary for adults.33 This last change, though minor, seems to be in the wrong direction, as other countries, such as the Netherlands, appear to have curbed youth unemployment through bold reductions in the minimum wages for young workers (see Box 2).34

Labor Market Reform in the Netherlands1

In the Netherlands, the OECD-standardized unemployment rate fell from 11.0 percent in 1983 to 5.4 percent in 1992. The unemployment rate among youth dropped from 24.9 percent to 7.8 percent over the same period. It is tempting to attribute these positive results at least in part to labor market measures, though there is a fervent debate on whether this is justified. Some of the salient points of the reform can be summarized as follows.

• Since 1982, unions and employers have agreed to moderate wage growth in order to stimulate employment creation. The government also reduced the civil servants’ wage bill as a share of GDP, by containing wages and the number of employees.

• The government reduced the wedge between gross labor costs and net wages, particularly at the low end of the wage spectrum. For the average worker, real gross wages declined by 1.1 percent over 1983-96 and real net wages grew by 11.6 percent.

• Unemployment and disability benefits were reduced, and eligibility was tightened. The duration of unemployment benefits was reduced from 2½ years to ½ year for workers below age 23, with smaller but still substantial cuts for older workers. Benefits were cut from 80 percent of the last earned wage to 70 percent (in 1986).

• Minimum wages were reduced, particularly for youth. The minimum wage as a ratio to the minimum wage for an adult currently amounts to 30 percent for a 15-year-old, 45.5 percent for an 18-year-old, and 85 percent for a 22-year-old. For adults, the minimum gross wage was 51.1 percent of the average gross wage in 1995.

1Further details on labor market reform in the Netherlands are provided in SM/97/139.

• Clarification of the conditions for the use of temporary contracts, in an attempt to avoid abuse. For the contract for specific works or activities, the new wording adds that it is intended for activities “with their own autonomy within the operations of the firm, and whose duration, while limited, is uncertain.” For the contract for special production circumstances (intended for ordinary activities of the firm in the presence of unusually high demand), whose basic duration of 6 months could be extended—previously with no specified limit—through collective agreement, an absolute limit of 18 months has now been set.

• Elimination of the contract for new activities, which, according to the social partners, had proved detrimental to permanent employment. This contract was temporary (six months to three years) and had no dismissal costs, but had to be converted into a permanent contract (with ordinary dismissal costs) after three years if the worker was to remain employed by the same firm. It was accessible only to new firms or existing ones that launched a new activity. Its initial rationale had been ultimately to promote the creation of new permanent jobs by entrepreneurs who faced considerable uncertainty in the early stages of a new activity and might have been deterred from hiring workers by the high dismissal costs attached to ordinary permanent contracts. In practice, abuse of this contract appears to have been widespread and few workers saw these temporary contracts converted into permanent jobs.

• Establishment of a bipartite commission (involving representatives of the trade unions and employers’ associations) to follow up on the implementation of the agreement and its effectiveness, provide a forum for ongoing efforts to improve the labor market, and suggest possible additional steps and corrective measures over the next few years.35

• Statement of principle on the streamlining of the bargaining system, to analyze ways in which the overlapping of several layers of labor market negotiation (national, sectoral, provincial, firm level) can be avoided. The parties signing the agreement (CEOE, CEPYME, UGT, CCOO) stated that clarification was needed on which level should deal with which aspect of the negotiations. An effort would be made to find out whether all participants in a given sector conducted negotiations according to the system that the sector had chosen (e.g., national/sectoral, provincial, or firm-level negotiations) and to assess whether the current system was appropriate. For example, an issue that the employers’ associations and trade unions would raise with the entrepreneurs and workers they represented was whether it would be desirable for the national/sectoral level to address wage structure while leaving decisions on the actual wage increase at the firm level.

D. Early Indicators on the Impact of the Reform and Recent Developments

71. Since the reform took effect, the number of permanent contracts signed has increased sharply, both in absolute terms and as a share of the total number of contracts signed. The number of permanent contracts signed between May 1997 and January 1998 amounted to 670,000 contracts (of which 460,000 contracts, i.e., 68.7 percent, were of the new type—153,000 new contracts and 307,000 conversions of temporary contracts) compared with 259,000 contracts between May 1996 and January 1997.36 Moreover, permanent contracts as a share of all contracts signed rose from 3.8 percent in May 1996-January 1997 to 8.5 percent in May 1997-January 1998.

72. Although part of the sharp increase in the number of permanent contracts since May 1997 may be due to the fact that entrepreneurs waited for the reform to take effect before making new hires, this factor appears to have played only a limited role. In fact, the number of permanent contracts signed did not decline in the months prior to the reform (Figure 8). Another major factor underlying the popularity of the new type of permanent contracts may have been the considerable fiscal incentives associated with them, but it is difficult to determine their exact role.

Figure 7.
Figure 7.

Spain: Average Dismissal Costs, 1980-96

Citation: IMF Staff Country Reports 1998, 053; 10.5089/9781451812015.002.A002

Sources: Ministry of Finance; and Instituto Nacional de EstadisticaAverage dismissal costs refer to dismissals for which an agreement is reached between entrepreneur and worker through the obligatory “mediation, arbitration, and conciliation” procedure. About a third of dismissal procedures are resolved in this manner.
Figure 8.
Figure 8.

Spain: Registered Contracts, 1994-98

Citation: IMF Staff Country Reports 1998, 053; 10.5089/9781451812015.002.A002

Source: Boletin de Estadisticas Laborales, Ministry of Labor.

73. Employment survey data indicate a slight decline in the share of temporary employment, from 33.6 percent in the second quarter of 1997 to 33.2 percent in the fourth quarter of 1997.37 These early results, cannot be conclusively attributed to the reform, they are consistent with the view that the reform has had beneficial effects on permanent employment.

74. Beyond the immediate impact in terms of the creation of permanent jobs, a positive aspect of the reform is that it reflects and fosters a climate of social peace. The number of hours lost to strikes has fallen sharply in recent years (Figure 9, top panel) and wage demands by the trade unions have been very moderate since 1994, leading to wage settlements almost in line with expected inflation (Figure 9, bottom panel). These broader developments are likely to promote job creation and economic growth.

Figure 9.
Figure 9.

Spain: Industrial Relations, 1979-98

Citation: IMF Staff Country Reports 1998, 053; 10.5089/9781451812015.002.A002

Sources: Bank of Spain; and WEO forecast.1/ Expected inflation is that included in the budget, which acts as a focal point in the negotiations.

75. While expressing satisfaction with the early effects of the May 1997 reform, the government has recently stated that it would welcome further measures to reform the labor market. In particular, it has singled out two areas for possible complementary measures, namely unemployment compensation and part-time contracts. Concerning the latter, there seems to be considerable potential for further employment growth through the creation of part-time jobs. In fact, in spite of a relatively rapid increase in part-time employment since the early 1990s (Figure 10), Spain’s share of part-time employment remains only about half of the EU average (Table 8).

Figure 10.
Figure 10.

Spain: Part-Time Wage Earners, 1988-97

Citation: IMF Staff Country Reports 1998, 053; 10.5089/9781451812015.002.A002

Source; Bank of Spain.
Table 8.

Spain: Part-time Employment as a Share of Total Employment

(In percent)

article image
Source: Eurostat, Labour Force Survey.

E. Preliminary Assessment

76. The May 1997 labor market reform took place against the background of improved industrial relations, which may contribute to the growth of output and employment. Overall, the reform seems to be a significant step in the right direction. It may lower the share of temporary employment, a desirable objective in itself. In addition, it may reduce the frictional unemployment that results from the continual rotation of workers between temporary jobs. At the same time, it remains uncertain whether the reform will be sufficient to make a major dent in unemployment.

77. In the absence of reliable information on the share of dismissals that are deemed justified by the courts since the reform took effect, the most important measure as of this time seems to have been the introduction of the new permanent contract with lower dismissal costs. The sharp increase in permanent contracts signed since May 1997 bodes well for a reduction in the share of temporary employment, although the initial popularity of the new type of permanent contract could partly reflect the associated fiscal incentives and the unwinding of some delay in hiring during the months leading up to the reform. On the negative side, the new type of permanent contract still carries dismissal costs that are about 50 percent above the already high EU average.

78. The reform also includes some additional restrictions on the use of temporary contracts, most notably by imposing a maximum age of 21 for the new training contract, compared with 25 for the apprenticeship contract that was eliminated. While the spirit of these measures is to avoid abuse and to ensure that employers make use of the new permanent contracts when possible, rather than unnecessarily rolling over temporary contracts, such restrictions may slightly reduce opportunities to curb unemployment, especially among youth.

79. Most important, the May 1997 reform leaves several key areas untouched, including the generosity and duration of unemployment benefits. Spain does not stand out among industrial countries in this respect, but the magnitude of its unemployment problem implies that it could gain the most from increasing labor force participants’ incentives to take jobs. Recent statements by the government that it will consider further measures to reform the labor market are therefore welcome.


Prepared by Paolo Mauro.


The share of temporary workers in total employment was not particularly high by international standards in the early 1980s, but it doubled after the 1984 labor market reform promoted the use of temporary contracts in an attempt to curb the rise in unemployment.


Dismissals settled through the “mediation, arbitration, and conciliation” procedure (approximately a third of all dismissals) resulted in average dismissal costs amounting to about 13 months of average pay in 1996 (see Table 6 and Figure 7). Survey evidence shows that dismissal costs often exceed the statutory 42 months of pay for unjustified dismissals, as employers seek to avoid lengthy and costly legal proceedings.


The 1994 reform is described in detail in SM/95/25.


Article 52.c) of the Estatuto de los Trabajadores. The economic causes remain unchanged: “to overcome a negative economic situation” (usually interpreted as loss-making).


The cost of justified dismissals (20 days per year worked, with a maximum of 12 months) also remains unchanged.


The imputed yearly revenue for the purposes of IRPF calculations would ordinarily amount to Ptas 2,000,000 (about US$14,000) for each employee.


For practical purposes the duration of the two contracts is likely to be broadly the same.


Under the old apprenticeship contract, workers above 18 years of age received salaries amounting to at least 70 percent of the minimum interprofessional wage (salario minimo interprofesional—SMI) during the first year of the contract, 80 percent during the second year and 90 percent during the third year. Under the new training contract, workers above 18 must be paid at least the SMI for adults (with some adjustment for the number of hours worked). Workers below 18 years of age will continue to receive salaries of at least 85 percent of the SMI for their age, which is roughly two thirds of that for adults.


At the same time, a recent study (Juan Dolado et al., “Minimum Wages: The European Experience,” Economic Policy Octobzv 1996) finds only very limited evidence that the cut in minimum wages in the Netherlands contributed to an increase in youth employment.


A tripartite commission (including representatives of the government) has been established to analyze the temporary work agencies.


The data refer to the gross flow of contracts registered with the Ministry of Labor.


The data are from the National Statistical Institute’s Survey of Active Population. Permanent employment in the survey data appears to have risen somewhat less than might have been expected on the basis of the data on contracts registered with the Ministry of Labor. It is still too early to determine the reasons for the apparent discrepancy between these two distinct data sources.

Spain: Selected Issues
Author: International Monetary Fund