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Wage Rigidity, Implicit Contracts, Unemployment and Economic Efficiency

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  • Newbery, David M G
  • Stiglitz, Joseph E

Abstract

Implicit contract theory has been successful in explaining wage rigidity but not unemployment. We argue that the theory has paid insufficient attention to (i) the general equilibrium aspects and (ii) constraints limiting the set of feasible contracts. Implicit, as opposed to explicit contracts, must specify an enforcement mechanism, can only be conditional on observable information, and must be of limited complexity. We first show that in a simple general equilibrium model without these restrictions contracts do not result in unemployment but that the market equilibrium is not constrained Pareto efficient. Our main object is to examine the consequences of these three restrictions. Natural restrictions on enforceability or complexity alone do not lead to unemployment, but limited observability may lead to unemployment. If, however, two or more restrictions apply, then unemployment may result. In particular, we show that periodic unemployment can arise if contracts are of limited complexity and cannot be enforced through third parties.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 67.

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Date of creation: Jun 1985
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Handle: RePEc:cpr:ceprdp:67

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Keywords: Implicit Contracts; Unemployment; Wage Rigidity;

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Cited by:
  1. Kittel, Bernhard, 2001. "How bargaining mediates wage determination: An exploration of the parameters of wage functions in a pooled time-series cross-section framework," MPIfG Discussion Paper 01/3, Max Planck Institute for the Study of Societies.
  2. Giulio Palermo, 2005. "Misconceptions of Power: From Alchian and Demsetz to Bowles and Gintis," Working Papers ubs0510, University of Brescia, Department of Economics.
  3. Anne Perrot, 1990. "La théorie des contrats implicites : bilan et perspectives," Économie et Prévision, Programme National Persée, vol. 92(1), pages 15-20.

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