AN EFFICIENCY-WAGE MODEL WITH EXPLICIT MONITORING - UNEMPLOYMENT AND WELFARE IN AN OPEN-ECONOMY

This paper develops an efficiency-wage model of involuntary unemployment in a small open economy, which uses two factors to produce three goods, one of which is (non-traded) monitoring aimed at reducing shirking by workers in all industries. The analysis shows how a tariff on imports may lower employment but, paradoxically, raise social welfare at the same time. As the paper also demonstrates, the optimal policy combination includes not only taxes on capital and monitoring as well as a subsidy on employment, but also (despite the small-country assumption) a tax on consumption.