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Dual Labor Markets: A Macroeconomic Perspective.

Dual Labor Markets brings together into a tidy package the contributions of Gilles Saint-Paul to the theory of dual labor markets. His research agenda is to show that one may construct a more empirically relevant macro-economic model by viewing employment opportunities as being divided between "good" and "bad" jobs. A worker in a "good" job has a long-term attachment to the firm, with correspondingly high investment in human capital. A job is relatively "bad" to the extent that it entails high turnover, low wages, and long spells in the pool of the unemployed between jobs.

In the absence of legislation, and given the combination of demand fluctuations and the higher productivity of long-tenure relationships, profit-maximizing firms would offer both long- and short-tenure employment contracts in equilibrium. As Gary Becker has shown (Human Capital: A Theoretical and Empirical Analysis [New York: Columbia University Press, 1975]), the fact that the firm has made a greater investment in a long-tenure employee implies that even if all workers are ex ante identical, ex post the long-tenure employees will be more productive and have higher wages. Chapters 1-4 outline a dynamic version of the efficiency wage model that generates a similar conclusion. It is also worth observing that a similar point has been made in the literature on the Japanese firm (see Masahiko Aoki, Information, Incentives, and Bargaining in the Japanese Economy [Cambridge: Cambridge University Press, 1988], p. 171).

After a brief discussion of the empirical literature on dual labor markets in Chapter 5, the author devotes the rest of the book to exploring the concept of dualism within the context of European political economy, where the tradition of mandated job protection effectively increases the cost of laying off workers. Chapter 6 explores the implication of increased labor flexibility on labor demand, and Chapter 7 addresses the question of wage formation. Chapter 8 examines the consequence of increased flexibility for the flow of temporary and permanent jobs in and out of the unemployment state. In Chapter 9, the consequences of heterogeneity in worker ability are examined. In particular, it is found that training programs may increase overall unemployment by decreasing the supply of unskilled labor (the flip side of increasing the supply of skilled labor). Chapter 10 presents a model in which an increase in firing costs results in an increase in the returns to education, and hence an increase in human capital accumulation. However, the author also highlights the fact that Schumpeterian growth models and political economy models have contrary predictions, and hence one cannot conclude that increasing firing costs is necessarily beneficial.

The final chapter of the book examines the political economy of labor market regulation. Saint-Paul begins by observing that increasing labor market flexibility in Europe is difficult due to the resistance of workers currently in "good" jobs. One solution is to use a conversion clause that assures incumbents some protection during the transition to a more flexible labor market. The author also observes, based on his study of the Spanish labor market, that once the transition begins, more workers face the threat of unemployment, further increasing the support for flexible labor contracts. Thus, the book finishes with the broad policy conclusion that European governments can partially solve the unemployment problem by slowly increasing the supply of jobs with little or no employment protection.

The useful contribution of this book is to present a collection of tractable dynamic general equilibrium models that allow one to explore the effect of endogenous contract rigidities. What I am less sure about is whether our understanding of labor markets is enhanced by thinking in terms of "dualism." As Horst Siebert observed, "Any labor market is surrounded by an array of institutional arrangements that form a complex web of incentives and disincentives on both sides of the market" ("Labor Market Rigidities: At the Root of Unemployment in Europe," Journal of Economic Perspectives, Vol. 7, No. 3 [1994], pp. 37-54). In the same issue of the Journal of Economic Perspectives, Stephen Nickell provides a review of the evidence on European unemployment ("Unemployment and Labor Market Rigidities: Europe Versus North America," pp. 55-74). This evidence suggests a story that is much more complex than the simple dual economy model with firing costs, yet surprisingly coherent in the sense that the unemployment rate seems to move in ways that can be predicted using standard price theory. Moreover, while there is evidence that there are wage differentials that are not explained by worker characteristics alone, as the work of John Abowd, Francis Kramarz, and David Margolis shows for France ("High Wage Workers and High Wage Firms," Mimeo, Cornell University, December 1996), the size of these differentials is an order of magnitude smaller than those explained by worker characteristics alone.

This suggests that the competitive model is still very useful for understanding the broad movements in prices and quantities. It is also important to try to understand why there was a movement for increased job protection in the first place. As Oliver Williamson has emphasized (The Economic Institutions of Capitalism [New York: The Free Press, 1985]), efficient governance of the employment relationship entails the ability of the firm and worker to enter into long-term agreements. One of the reasons one needs to have a long-term contract is precisely because in some circumstances the contract will mandate ex post inefficient outcomes as part of an ex ante efficient contract. There may be situations in which one wishes to undo these contracts ex post, but such an action should be taken with sensitivity to its implications for future contract formation.

Hence, I am not sure that dualism, a concept introduced by Arthur Lewis to describe the natural division in a developed economy between the low-productivity agricultural sector and a growing industrial sector ("Economic Development with Unlimited Supplies of Labour," Manchester School, Vol. 22 [1954], pp. 139-91), is relevant to modern labor markets with their continually changing demands for skilled workers. For many workers the problem is not so much one of unemployment, but of how to deal with an unexpected capital loss on their human capital investments. The variety of institutions that European countries have adopted to deal with these adjustment problems is a reflection of the different ways that policy makers trade off total employment against income equality. Hence, while this book is an excellent review of some of the interesting dynamics of two-sector models with firing costs, I did not find it sufficiently sensitive to the details of either contract formation or European political economy to provide an adequate starting point for thinking about the European unemployment problem. Some of the important social and economic issues are nicely illustrated in the recent English film The Full Monty, where unemployed steel workers prefer to risk all in the entertainment industry rather than to accept what they perceive to be demeaning "bad" jobs.

W. Bentley MacLeod Professor of Economics and Law University of Southern California
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Author:MacLeod, W. Bentley
Publication:ILR Review
Article Type:Book Review
Date:Apr 1, 1998
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