|M.Sc Student||Saher Zidan|
|Subject||The Effectiveness of Monitoring and the Instutional|
Design of Labor Markets
|Department||Department of Industrial Engineering and Management||Supervisor||Dr. Bental Benjamin|
Substantial institutional reforms have been carried out in most OECD countries during the last four decades, significantly changing the institutional design of their labor market. At the same time, empirical data has indicated that alongside increasing labor productivity, labor shares in national income, wage per efficiency unit and the ratio between labor in efficiency units and capital have decreased.
In order to explain the aforementioned macroeconomic trends, Bental and Demougin (2009) model an economy characterized by two contractual frictions:
1. Labor relations are affected by moral hazard requiring firms to offer incentive contracts.
2. Investment is irreversible and precedes the contract with labor, creating a form of holdup on investment which enables labor to extract part of the quasi-rent.
This model presents a bargaining problem over the labor contract between a representative employee and a representative firm, where the bargaining power of labor is given by the economy’s institutional framework. The contract determines the level of effort and the bonus required to implement it. The institutional design affects the outcome. For example, allocating high bargaining power to labor induces high-powered incentives and high effort. This mitigates the inefficiencies stemming from the moral hazard problem. At the same time, a large portion of the quasi-rent appropriated by labor is detrimental to capital investment. Consequently, the institutional setup generates a trade-off between induced effort and investment. At the optimum, the social planner selects labor’s bargaining power to maximize social welfare. The optimal allocation of bargaining power is affected by the effectiveness of the monitoring technology. As this technology improves, the moral hazard problem becomes less significant and the social planner reduces the bargaining power of labor.
The thesis uses the same framework as that of Bental and Demougin (2009). However, it replaces the Nash bargaining procedure of that paper with the Kalai-Smorodinsky approach as introduced by Thomson (1994), and compares the results through numerical experimentation.
The thesis finds that improvements in monitoring have a negative effect on labor share and on wage per efficiency units. However, the ratio between labor in efficiency units and capital is not significantly affected by these improvements. Labor productivity is positively affected up to a certain point after which it begins to decline with increased monitoring precision.
An optimal social design under Nash bargaining yields a greater social welfare than that under the Kalai-Smorodinsky approach. On the positive side, the Nash specification shows more consistency with macroeconomics trends observed in most OECD countries.