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Unemployment and Insurance

  • Sherwin Rosen

This paper elaborates equilibrium properties of contract labor markets when cost barriers limit labor mobility in response to demand and productivity shifts. Unemployment is sustained because the marginal value of labor is not equated across all firms; however the equilibrium contract optimally allocates a worker's time between market and nonmarket uses, given transactions cost-mobility constraints. Contracts provide full unemployment insurance for risks that are diversifiable by pooling among firms. Nondiversifiable (macro) risks are only partially shifted,largely through self-insurance (contingency saving). Increasing diversifiable risk has social value, similar to the value of an option. Increasing nondiversifiable risk has negative value because it reduces lifetime consumption. The main empirical implication of contract theory is shown to be closely related to the permanent income hypothesis and establishes linkages between labor activities and consumption behavior. It is atheory of consumption rigidity rather than wage rigidity. Another empirical implication is that unemployment incidence is proportional to comparative advantage in normarket production. Layoffs are ordered by workers' relative productivity in nonmarket compared with market sectors. The theory is used to analyze some features of the U.S. employment system. Its empirical support is briefly reviewed.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1095.

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Date of creation: Mar 1983
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Publication status: published as Rosen, Sherwin. "Unemployment and Insurance." Carnegie-Rochester Conference Series on Public Policy, Vol. 19, no. 1, (1983) pp. 5-49.
Handle: RePEc:nbr:nberwo:1095
Note: LS
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  1. Chari, V V, 1983. "Involuntary Unemployment and Implicit Contracts," The Quarterly Journal of Economics, MIT Press, vol. 98(3), pages 107-22, Supplemen.
  2. Grossman, Sanford J & Hart, Oliver D, 1981. "Implicit Contracts, Moral Hazard, and Unemployment," American Economic Review, American Economic Association, vol. 71(2), pages 301-07, May.
  3. Hall, Robert E, 1982. "The Importance of Lifetime Jobs in the U.S. Economy," American Economic Review, American Economic Association, vol. 72(4), pages 716-24, September.
  4. John Abowd & Orley Ashenfelter, 1980. "Anticipated Unemployment, Temporary Layoffs and Compensating Wage Differentials," Working Papers 517, Princeton University, Department of Economics, Industrial Relations Section..
  5. Robert E. Hall & Edward P. Lazear, 1982. "The Excess Sensitivity of Layoffs and Quits to Demand," NBER Working Papers 0864, National Bureau of Economic Research, Inc.
  6. Hamermesh, Daniel S, 1982. "Social Insurance and Consumption: An Empirical Inquiry," American Economic Review, American Economic Association, vol. 72(1), pages 101-13, March.
  7. Lucas, Robert Jr. & Prescott, Edward C., 1974. "Equilibrium search and unemployment," Journal of Economic Theory, Elsevier, vol. 7(2), pages 188-209, February.
  8. Grossman, Herschel I., 1978. "Risk shifting, layoffs, and seniority," Journal of Monetary Economics, Elsevier, vol. 4(4), pages 661-686, November.
  9. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
  10. Robert E. Hall, 1987. "Consumption," NBER Working Papers 2265, National Bureau of Economic Research, Inc.
  11. Hayashi, Fumio, 1982. "The Permanent Income Hypothesis: Estimation and Testing by Instrumental Variables," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 895-916, October.
  12. Dale T. Mortensen, 1978. "Specific Capital, Bargaining, and Labor Turnover," Discussion Papers 320, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  13. Baily, Martin Neil, 1974. "Wages and Employment under Uncertain Demand," Review of Economic Studies, Wiley Blackwell, vol. 41(1), pages 37-50, January.
  14. Diamond, Peter A, 1982. "Aggregate Demand Management in Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 881-94, October.
  15. Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December.
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