Labor is one of the most heterogeneous products traded in a modern economy. The competitive market for a commodity, where all units are interchangeable and all trade for the same price, could hardly be a worse description of the labor market. No Walrasian auctioneer determines the wage. We study survey evidence on the ways that an employer and a worker determine the wage at the outset of their relationship. Our findings support the predictions of theories of wage determination about the relationship among the level and dispersion of wages, on the one hand, and the incidence of bargaining, on the other hand.
The extensive literature on this topic considers two main cases. The first is wage posting. Here an employer defines a job in terms of duties and qualifications, and commits to a wage. If a candidate is found qualified and interested, the employer offers the wage on a take-it-or-leave-it basis. The second is bargaining. The employer makes an initial offer, but the candidate can make a counteroffer for a higher wage, if so inclined. A key difference between the two modes is the employer’s commitment not to entertain a counteroffer. To the employer, the advantage of posted wages is that the employer may appropriate a large fraction of the surplus of a match. The disadvantage is that a posted wage precludes a match with a candidate whose reservation wage is higher than the posted wage but whose productivity is even higher. Bargaining with this worker would have gained some of the surplus. Bargaining is in the interest of the employer if qualified workers have heterogeneous skill levels.
In the United States, a small fraction of workers in private employment and a larger fraction in government employment receive pay under the terms of collective bargaining agreements. From the point of view of an individual worker, the resulting wage is posted rather than bargained individually. We identify unionized and government workers in our analysis of the survey data.
In addition to wage posting and bargaining, one could imagine a labor market where employers can commit to ignore counteroffers, on the one hand, but make a custom offer to the applicant rather than offering the same wage to all qualified applicants, on the other hand. This market would encounter the Diamond paradox. An employer would make an offer that just meets a worker’s reservation wage. The worker knows that the wage is below the maximum that would be acceptable to the employer, but also knows that the employer will not consider a counteroffer that is below that maximum but better than the employer’s original offer.
The worker will accept the original offer. The only equilibrium in the labor market under these conditions is for workers to earn the bare minimum needed to attract them to the market. Workers would not earn the Ricardian rents that normally make up a substantial fraction of wages. We do not believe that this equilibrium occurs in U.S. labor markets. Most workers, especially men aged 25 to 55, appear to have strong preferences for higher market goods consumption together with the higher market work needed to finance that consumption rather than lower levels of both, a clear sign that they have not been pushed to their participation reservation points.
Wage formation has a central role in the theory of unemployment. A positive level of unemployment is inevitable given the frictions in the labor market—some workers will always be in the process of locating a better use for their services after a decline in their productivity in earlier jobs. The anticipated wage determines the payoff to workers to search for new jobs and to employers to recruit new workers. Some bargaining protocols imply that the bargained wage is insensitive to conditions in the labor market, such as productivity and unemployment—see Hall and Milgrom (2008). In these models, the incentive for employers to recruit new workers falls in times of low productivity. As a result, unemployment is sensitive to driving forces such as productivity; the models can deliver realistic volatility of unemployment. By contrast, in models where employers post wages and adjust them each period to their optimal levels, the response of unemployment to driving forces tends to be small and the observed volatility of unemployment remains unexplained.
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PDF Ebook Evidence on the Determinants of the Choice between Wage Posting and Wage Bargaining
