LABOR SUBSIDIES AND JUST-CAUSE EMPLOYMENT LAWS IN AN EFFICIENCY WAGE MODEL

Efficiency wage models differ from standard labor market models in that wages do not necessarily clear markets. Wages act as devices to encourage work effort or, more generally, to increase productivity. Firms set their wages above the market clearing level and there is involuntary unemployment. This article uses a shirking model to discuss optimal government policies. Section 2 presents the model. Section 3 considers the welfare effects of unemployment compensation, two subsidies, and just-cause employment laws. These two subsidies are wage-rate subsidies (paid based on the total wage bill) and employment subsidies (paid per worker employed). The use of wage-rate subsidy improves welfare. The welfare effects of employment subsidies are uncertain. The results yield a necessary and sufficient condition for an increase in welfare. The last part of section 3 extends the model to discuss just-cause employment policies. These are laws that prevent or punish unjust dismissals. Welfare may rise or fall. The condition for an improvement in welfare is the same as that for the employment subsidy. -from Author