The Bank of Spain Proposes Reducing The Cost Of Dismissal And Adopting The Austrian Model

The Bank of SpainPablo Hernández de Cos, Bank of Spain's governor

According to the Governor of the Bank of Spain, Pablo Hernández de Cos, NGEU funds may be used to facilitate the approval of structural reforms that entail costs for certain agents in the short term. The chances of gaining approval for certain legislative changes, when the benefits only become tangible after some time, may be increased if the groups that lose out temporarily are compensated. The setting up of a capitalisation fund for each employee to finance part of their severance pay in the event of dismissal is an example of a reform that is desirable for the economy as a whole, but costly for certain agents in the short run.

The sizeable difference in Spain between the costs of terminating permanent and temporary employment contracts – which are much higher in the first case, and more so the longer the job tenure – means that job losses fall disproportionately on temporary workers. To mitigate this problem of excessive duality in the degree of protection of different workers, according to their type of contract, the 2010 labour reform proposed setting up an individual capitalisation fund to be endowed with an amount equivalent to a certain number of days’ wages for each year of service. This amount would be deducted from the severance pay that employers are required to pay in the event of dismissal.

Workers would recover the amount accumulated in the fund not only in the event of dismissal, but also when moving to a new job in another geographical area, to pay for training or else upon retirement. Furthermore, if workers were to move to another firm in the same geographical area, they would take the balance of the fund with them. Notable among the merits of this scheme are a better alignment between firms’ dismissal decisions and the individual productivity of each employee, since it reduces the differences in the amount of compensation paid by the firm at the time of dismissal according to the worker’s type of contract or job tenure.

The NGEU programme funds could be used to mitigate some of the extra costs for firms during the transition to the new scheme, given that the compensation rights in current contracts would remain valid. If the new scheme is financed out of firms’ social security contributions, companies would have extra costs during the initial years of the scheme, since they would have to pay, simultaneously, the new contributions and the severance pay accumulated prior to the introduction of this mechanism. By way of example, Box 2.4 suggests a formula for these transition costs, whereby the aggregate amount received by the whole population of workers in the long term does not change with respect to the current system.

To this end, it is envisaged that, during the initial years following the introduction of the new scheme, the different levels of government could subsidise a declining proportion of the transition costs. The use of part of the NGEU funds would allow the mechanism to be endowed with the necessary resources for its initial launch. Moreover, this use would be in line with the conditions laid down in the Commission Regulation, which states that to be eligible for NGEU funds, reforms must help to boost growth or improve economic or environmental sustainability. This Regulation refers specifically to pension system and labour market reforms as examples of reforms eligible for NGEU funds.

Read More:

About the Author

The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.