Risk sharing on the labour market and second-best wage rigidities

The starting point of the analysis is that a significant proportion of the labour force is not covered by efficient labour contracts. In particular, the non-existence of forward labour contracts limits the opportunity of efficient risk-sharing through private arrangements among young labour-suppliers and capital-owners. In such a context, state-dependent labour taxes and employment subsidies would be required to achieve ex ante Pareto efficiency. In the absence of employment subsidies, a certain (limited) degree of downward wage rigidity is in general Pareto superior to full wage flexibility. At the second-best optimum so defined, productive efficiency is sacrificed in some states, in order to achieve greater efficiency in risk-sharing. Thus, the unemployment associated with wage rigidity is inefficient, though voluntary due to the levels of benefits, and second-best efficient. A limited degree of wage discrimination by hiring date is typically part of the second-best policy.

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