Silicon Valley versus Route 128: A Search and Contracting Approach

Labour markets in different regions or countries vary significantly with respect to turnover rates, remuneration practices, investment in general and firm-specific human capital, and the frequency of employee-driven start-ups. Examples include the Silicon Valley versus Route 128 in the US, and the US versus Japan and Europe. In this paper, we show how differences in labour market outcomes may arise endogenously, and how they in turn may affect human capital investment, entrepreneurship, and welfare. Two key elements of our model are firms' choice between short- and long-term wage contracts (the latter with deferred compensation), and the search market for experienced employees. We show that multiple equilibria may exist: a low-turnover equilibrium with deferred wage compensation and high effort, and a high-turnover equilibrium with low effort and no deferred compensation. We argue that low-turnover equilibrium is associated with high firm-specific human capital and a low level of entrepreneurial activity, in contrast with high-turnover equilibrium, which is characterised by a stronger emphasis on general human capital and higher levels of entrepreneurial activity.