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Implicit Contracts, Unemployment, and Labor Market Segmentation

  • Altmann, Steffen

    ()

    (University of Copenhagen)

  • Falk, Armin

    ()

    (University of Bonn)

  • Huffman, David B.

    ()

    (University of Oxford)

We analyze the impact of imperfect contract enforcement on the emergence of unemployment. In an experimental labor market where trading parties can form long-term employment relationships, we compare a work environment where effort is observable, but not verifiable to a situation where explicit contracts are feasible. Our main result shows that unemployment is much higher when third-party contract enforcement is absent. Unemployment is involuntary, being caused by firms' employment and contracting policy. Moreover, we show that implicit contracting can lead to a segmentation of the labor market. Firms in both segments earn similar profits, but workers in the secondary sector face much less favorable conditions than their counterparts in primary-sector jobs.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 5001.

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Length: 32 pages
Date of creation: Jun 2010
Date of revision:
Handle: RePEc:iza:izadps:dp5001
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