Equilibrium Wage Arrears: Institutional Lock-In of Contractual Failure in Russia

We present a model of managerial choice of wage delays that implies a possibility of multiple equilibria in the level of arrears. Positive feedback arises because each employer's wage arrears choice has externalities for other employers by affecting worker quit, effort and protest behavior and the probability of legal penalties. We study the case of three equilibria, distinguishing two that are stable - the "punctual payment equilibrium" and the "late payment equilibrium" - and one unstable "critical mass equilibrium," a threshold of arrears in the local labor market beyond which even profitable firms may adopt the practice. Our econometric analysis of linked employer-employee data for Russia provides evidence that workers' responses to wage delays are attenuated by local labor market arrears, that the wage arrears reaction function exhibits positive feedback, and that the theoretical conditions for multiple equilibria under symmetric local labor market competition are satisfied empirically in 1995 and 1998. Simulation results imply clustering of regions around two stable levels of arrears, with the late payment equilibrium characterized by six months overdue wages for a typical worker in 1995 and nine months in 1998.