Efficiency Wages in Heterogenous Labour Markets Pavel Ryska
Efficiency Wages in Heterogenous Labour Markets Pavel Ryska, Jan Průša Institute of Economic Studies, Charles University Prague PCPE, March 26, 2010
Outline Motivation Efficiency wage models Solow Shapiro-Stiglitz General approach to heterogenous markets Conclusion
Motivation Efficiency-wage models derive involuntary unemployment from firm optimization They serve as a proof of market failure We show that this result stems from two flaws: neglecting labour heterogeneity inner contradiction: voluntary choice of workers causes involuntary unemployment
Simple Solow model Labour efficiency depends on “effort function”, which itself depends on wages Then firms choose wage and labour which solves: max F(e(w)L) – w. L Optimal wage is given by the unit wage elasticity of effort: e'(w)/(e/w) = 1
Two fundamental errors 1. Different levels of effort constitute labour of different qualities and hence trade on different markets with different prices. Firm optimizes F(L 1, . . . , Ln) – w 1 L 1 –. . . – wn. Ln 2. The effort decision of a worker is voluntary and intentional, so resulting unemployment cannot by definition be involuntary. That is, the effort function is worker-
Shapiro-Stiglitz model • • Imperfect monitoring of work effort Firms know workers may shirk – they offer higher wages to discourage shirking → no-shirking condition (NSC), as opposed s to L Equilibrium with involuntary unemployment s Problem: inner contradiction about L. Shapiro & Stiglitz tacitly redefine labour supply and shift its original meaning into NSC.
Welfare implications of Shapiro-Stiglitz model Existence of M identical firms is questionable. They dispute income distribution based on marginal product and would prefer wages equal to average product. But then each labourer could be self-employed. A flavour of Marxist “surplus” arguments in the model.
General characteristics model (1) A good may have up to r characteristics, but different goods may share the same characteristics. Transformation from goods to characteristics z = Bx Consumer utility is defined on characteristics space: max u(z) s. t. z = Bx x≥ 0 px ≤ Income
General characteristics model (2) Consumers choose only those goods which have the most desired characteristics and corner solutions become the standard. When x = workers, then unemployment can be interpreted as a wage-characteristic mismatch. Workers have to change either their wage or their characteristic to turn the corner solution in their favour.
Conclusions The theory of efficiency wages can help us understand heterogeneous labour markets. To achieve this aim, theory needs to be reformulated and get rid of the main inconsistencies. When quality-specific labour markets become separated, unemployment can no longer be interpreted as involuntary.
Key texts n n Solow, R. (1979): Another Possible Source of Wage Stickiness. Journal of Macroeconomics, No. 1. , pp. 79 -82. Shapiro, C. , Stiglitz, J. E. (1984): Equilibrium Unemployment as a Worker Discipline Device. American Economic Review, No. 3, pp. 433444.
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