Moral Hazard and Unemployment in Competitive Equilibrium
Patrick Rey and
Joseph Stiglitz
No 32700, NBER Working Papers from National Bureau of Economic Research, Inc
Abstract:
Principal-agent models take outside options, determining participation and incentive constraints, as given. We construct a general equilibrium model where workers’ reservation wages and the maximum punishment acceptable before workers quit are instead determined endogenously. We simultaneously extend the standard effort efficiency-wage model by incorporating noisy signals, labor market frictions, and the possibility of performance-based pay, analyzing the equilibrium response to an adverse signal, and establishing conditions under which equilibrium entails lowering wages (performance contracting) rather than firing. We provide a complete analysis of the general equilibrium comparative statics, showing, for instance, that frictions (sand-in-the-wheels) may decrease unemployment and that the equilibrium is determined by two simple aggregates which depend on the parameters of the economy, interpretable as the intercept and slope of a pseudo-labor supply curve, embedding all the binding constraints (e.g., the no-shirking and labor market participation constraints). We also show that there may exist only a firing equilibrium, a no-firing equilibrium, multiple (firing and no-firing) equilibria, and no pure-strategy equilibrium. The economy is, in general, not efficient either in the selection of the form of equilibrium or the wages paid within any type of equilibrium. We discuss welfare enhancing government interventions, including publicly provided sand-in-the-wheels.
JEL-codes: D82 D86 E24 J31 J41 J63 J64 (search for similar items in EconPapers)
Date: 2024-07
New Economics Papers: this item is included in nep-cta, nep-dge, nep-lab and nep-mic
Note: LS
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