Wage & Employment Patterns in Labor Contracts

R. Cooper

• Publisher: Routledge
• Year: 2018
• Print ISBN: 9780415753661
• eBook ISBN: 9781136457524
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This book explores the micro-foundations and the macro-implications of the design of labour contracts.

Wage and Employment Patterns in Labor Contracts: Microfoundations and Macroeconomic Implications

RUSSELL COOPER¹
The University of Iowa, USA.

1. OVERVIEW

This monograph investigates the behavior of economies in which the trade of labor services occurs through contracts. In contrast to other commodities (such as currencies and many agricultural products), labor is generally not traded in an auction market between anonymous traders.² Instead, the employment relationship is relatively long-term and the terms of exchange are specified in a contract between the worker(s) and a firm. While market forces may have influenced the initial matching of workers and firms, it is useful to think of the ex post exchange of labor as being immune to outside market forces in that the levels of employment of wages are not determined directly by current market conditions. Furthermore, these contracts, particularly their wage component, provide insurance and credit which may not otherwise be available to the contractants. Under this interpretation, labor contracts are complex instruments influencing the allocation of labor time and consumption across states of the world and time which may substitute for missing markets. This view of the labor exchange process follows the contributions of Baily [8], Gordon [38] and Azariadis [3] and will form the foundation for our analysis.

Contracts are present in a wide range of countries and in most sectors of these economies. While the structure of these contracts may differ, it is clear that the trade of labor services lies outside of the auction setting. What factors determine the form of these contracts? How well do contracting arrangements function as a means of exchanging labor services? Do we obtain additional understanding of labor market and macroeconomic phenomena once we focus on contract-mediated exchanges?

There is a large and ever-growing literature on labor contracts which seeks to answer these questions. The goal of this monograph is to summarize and synthesize the theoretical contributions to labor and macroeconomics of this approach.³ For the most part, interest in labor contracts began with the quest by macroeconomists for theoretical support for the wage rigidities often assumed in their models. Despite this macro-motivation, the first contributions to this literature by Baily, Gordon and Azariadis were more micro-economic in nature and focused attention on the nature of contracts at the worker-firm level. As a consequence of this microeconomic research strategy, the contracts literature has also contributed to our understanding of certain labor market phenomena, such as seniority rules, and wage profiles, which have little or no apparent significance in macroeconomics.

To reflect these developments, the approach taken in this monograph will be a blend of micro- and macroeconomics. The analysis begins, in the first section, with a discussion of optimal labor contracts in a partial equilibrium setting. These contracts will be completely unrestricted in that all conceivable types of contingencies will be feasible. The discussion highlights the insurance role played by wages in these contracting models and some general properties of employment fluctuations. We also discuss the relation between the predictions of this model and those arising in a complete contingent markets equilibrium.

The following section departs from an environment of complete contingent contracts and considers the characteristics of labor arrangements when the set of feasible contracts is restricted. This section illustrates the impact of informational asymmetries, enforcement problems and other restrictions on patterns of wages and employment. In doing so, we generate interesting employment distortions, layoffs and related phenomena.

In Section 4, we turn attention to the macroeconomic implications of the contracting approach. We begin with a brief discussion of contracting arrangements across countries. Next we present a series of models which take these contracting features as given and explore their implications for business cycles and the design of macroeconomic policy. We complete this section by extending the basic contracting model to a macroeconomic setting to obtain some predictions about nominal compensation patterns and economy-wide employment fluctuations. Section 5 summarizes our results and discusses the future prospects for this approach.

Before proceeding further, it may prove useful to discuss the general approach of this monograph and its relation to other reviews of this literature. For the most part, this presentation concentrates on contracting models from a theoretical perspective. The discussion of empirical work is included mainly to provide some perspective on the theory. (This limited attention to the data reflects comparative advantage rather than preferences.) The emphasis, then, is in modeling contractual relations in a variety of environments. I have also tried to pay particular attention to techniques which can be applied to a wide range of problems beyond those considered here.

There are other surveys in the literature which cover some of the same material. Azariadis [6] reviews the literature up to, and including, some of the early work on contracting under asymmetric information. Hart [53] begins from there and presents a fairly complete discussion of contracting under asymmetric information. Rosen [82] covers contracting with symmetric and asymmetric information and explores models with and without worksharing. Rosen’s survey offers a slightly different perspective on the literature as he stresses the relationship between contracting models and more traditional models of the labor market.

This monograph attempts to provide more of a macroeconomic perspective and covers some topics which are omitted from these other reviews. Nonetheless, there is a considerable amount of overlap in the models presented in these four reviews. Moreover, all stress one central theme of the contracting literature: wages do not serve to decentralize labor decisions alone but are used as a means of shifting income across contingencies and time as well. As a consequence, wages do not directly reflect the marginal product of labor nor workers’ marginal rates of substitution between consumption and leisure.

2. THE BASIC PARADIGM

The basis for contracts

Before starting the actual analysis, we begin with a statement of the types of economies into which we are placing a labor contract. The contracting approach stems from the incompleteness of insurance and/or credit opportunities for workers. As is well-known, if markets were complete, in the sense of Arrow [2] or Debreu [24], all risks will be shared efficiently and the competitive equilibrium will yield Pareto optimal allocations. In such an economy, workers could then obtain insurance against fluctuations in both their wages and employment status. While labor contracts might be part of the complex market structure of this economy, they would be redundent in that the insurance elements of a labor contract could be provided by outside insurance companies.

The starting point of the analysis of labor contracts is the assumption that insurance against employment and compensation risk is not available to workers in the marketplace. We term this an assumption since the models employed generally do not explicitly provide a basis for this incompleteness of outside insurance opportunities. The usual story concerns the inability of insurance firms to perfectly monitor the employment status and wages of workers. Hence moral hazard problems may arise and insurance may not be feasible.

If workers, who are presumably risk averse with respect...

Table of contents

• Cover Page
• Half Title
• Title Page
• Copyright Page
• Contents
• Introduction to the Series
• 1. Overview
• References
• Appendix A: Proof of Proposition 2
• Appendix B
• Index