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Competition And Relational Contracts: The Role Of Unemployment As A Disciplinary Device

Author

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  • Martin Brown
  • Armin Falk
  • Ernst Fehr

Abstract

When workers are faced with the threat of unemployment, their relationship with a particular firm becomes valuable. As a result, a worker may comply with the terms of a relational contract that demands high effort even when performance is not enforceable by a third party. But can relational contracts motivate high effort when workers can easily find alternative jobs? We examine how competition for labor affects the emergence of relational contracts and their effectiveness in overcoming moral hazard in the labor market. We show that effective relational contracts do emerge in a market with excess demand for labor. Long-term relationships turn out to be less frequent when there is excess demand for labor than they are in a market characterized by exogenous unemployment. However, stronger competition for labor does not impair labor market efficiency: higher wages induced by competition lead to higher effort out of concerns for reciprocity.
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Suggested Citation

  • Martin Brown & Armin Falk & Ernst Fehr, 2012. "Competition And Relational Contracts: The Role Of Unemployment As A Disciplinary Device," Journal of the European Economic Association, European Economic Association, vol. 10(4), pages 887-907, August.
  • Handle: RePEc:bla:jeurec:v:10:y:2012:i:4:p:887-907
    DOI: j.1542-4774.2011.01058.x
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    References listed on IDEAS

    as
    1. Martin Brown & Armin Falk & Ernst Fehr, 2004. "Relational Contracts and the Nature of Market Interactions," Econometrica, Econometric Society, vol. 72(3), pages 747-780, May.
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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • C9 - Mathematical and Quantitative Methods - - Design of Experiments

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