This paper analyzes how firms can use job security as an incentive mechanism. The author examines how "macroeconomic job security" (measured by the reemployment probability) may affect productivity differently from "microeconomic job security" (measured by the probability of being retained). The authors describe the circumstances under which job security stimulates work effort. Then incumbent workers ("insiders") may have an opportunity to raise their wages above the market-clearing level without being replaced by unemployed workers ("outsiders"). In this context, involuntary unemployment can arise. Copyright 1988 by The editors of the Scandinavian Journal of Economics.
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