CONTRACTING AND INSIDER-OUTSIDER MODELS OF UNEMPLOYMENT
From the Walrasian assumption of a market-clearing wage on efficiency considerations - it was postulated that a higher than market-clearing wage leads to increased efficiency of workers for one reason or another. In this section we consider briefly some models wherein the wage differs from the Walrasian wage because of long-term relations between workers and firms. We consider here, very briefly, two kinds of models - contracting models and insider-outsider models.
The rationale underlying the contracting .models is that firms do not hire workers afresh each period. Workers continue to work for a firm for a large number of years because many jobs involve firm-specific skills that are not valued as much outside the firm and also because firms would find it costly to trbin new workers in these skills afresh each period. Workers are content to stay in their current jobs so long as their expected earnings over a much longer period than just, say, the current year are more than the opportunities that the workers would have outside the firm, even if in the current year their earnings are low. A worker in the United States, for example, lasts in a job, on an average, for ten years. In such a situation wages do not have to adjust every period to clear the labour market and the labour market clearly becomes non- Walrasian.
The relationships between workers and firms are determined in such cases by long-term contracts, arrived at through collective bargaining between worker unions and firms. We can consider two kinds of contracts. The first kind is a fixed-wage contract under which the wage is pre-determined and the film is free to choose the level of employment that it provides depending on the itate of the economy that emerges in each period. Workers agree to supply all the labour demanded by the firm. Wage rigidity and unemployment emerge immediately in such a model. A fall in labour demand does not affect the real wage because of the contract. The labour supply too cannot fall. The only thing that can happen when labour demand falls is that firms reduce employment at the fixed real wage.
The problem with this type of fixed-wage, variable employment contract is, however, that it is not an efficient contract because, under it, the marginal product of labour is generally not equal to the marginal disutility of work, and so it is possible to make both parties to the contract better OK You should recollect from your microeconomics units that contracts are said to be efficient if it is not possible to make one of the parties better off without making the other one worse off (pare to efficiency). This takes us to the idea of implicit contracts, which are efficient contracts unlike the simple fixed-wage contracts.
Implicit contracts are contracts between the firm and workers wherein the firm specifies the real wage and the employment that it will provide for each possible state of the economy. The contracts are so called because actual contracts in the real world do not explicitly specify employment and wage as a hction of the state of the economy. Not only are these contracts efficient, but also imply real wage rigidity and the consequences of real wage rigidity that we have examined in other contexts. The insider-outsider models are a development on the contracting models, wherein three categories of agents are recognised, viz., the firms, the workers that are employed (insiders), and the unemployed workers (outsiders). It is in the interest of the unemployed workers that the firms and the insider workers sign contracts providing for lower real wages and higher employment. But the unemployed, being outsiders, are not on the bargaining table. The real wage rigidity, that is implied, provides a non-Walrasian characteristic to the labour market and explains the existence of unemployment. Rich models have been built up in the literature analysing the interactions between the three categories of agents to explain some of the empirically observed characteristics of the labnur market. New Keynesian Theories of Unemployment