Profit Sharing Reconsidered: Efficiency Wages and Renegotiation Costs

Weitzman (1983, 1984, 1985, 1986 and 1987) strongly advocated policy measures to introduce profit sharing. His recommendations consisted of tax deductions on incomes derived from a share on profits. The basis for these incentives is the association of profit sharing and two sorts of externalities. First, if the economy is characterised by short run wage rigidity, profit sharing reduces short run unemployment. Second, profit sharing might reduce long run unemployment. Until 1985, profit sharing was justified in terms of its short run properties, and both contracts were considered to have the same long run equilibrium. This long run isomorphism was broken when both contracts were compared under hypotheses attempting to explain involuntary unemployment in the long run. A first microeconomic foundation for long run wage rigidity is the insider-outsider hypothesis. In Weitzman's (1987) insider-outsider analysis a sharing contract has a lower NAIRU than its wage counterpart, due to the decrease in insiders' power, when, first, the employer retains the employment decision, and second, there is no absolute collusion. Problems of stability of a share contract at full employment are added now to justify tax incentives, as the median worker will always (individually)prefer a decrease in the share parameter, implying that the economy converges to the wage system. Trade union's objectives change (Mitchell, 1987, Fung, 1988 and 1989, Pohjola, 1987, Jackman,1988, and Hoel and Moene, 1988): the consideration of firms’ profits in their own objective function lead to the superior Pareto properties of the share system1.