The response of household wealth to the risk of job loss: Evidence from differences in severance payments

The welfare consequences of legally mandated severance payments depend on whether or not households react to unemployment risk by accumulating higher savings. Using the 2002–2008 waves of a rich survey of wealth and consumption and the substantial variation in dismissal costs across contracts in the Spanish labor market, we estimate the link between the probability that several household members lose their job and the wealth of that household. We instrument the type of contract using regional variation in the amount, timing and target groups of subsidies given to firms to hire workers using high severance payment contracts. Our findings suggest that older workers covered by fixed-term contracts accumulate more financial wealth. For that group, a drop in severance payments increases average financial wealth by about 40% of annual labor earnings. We examine the responses of credit rejections and consumption growth to changes in job security to disentangle between credit constraints or precautionary saving motives, and the results favor the latter hypothesis.