In a perfectly competitive labour market we expect to see that the demand for labour is equal to the supply of labour at a given equilibrium wage. If the wage paid to employees is higher then this equilibrium wage then the demand for labour will fall short of the supply and will cause some rate of unemployment.(This working the opposite way as well.) When we find the wage being paid higher or lower than the equilibrium wage we expect to see it automatically falling or rising back to equilibrium level.
However if we cite examples from real life we can almost always see that this isnt the case. We can more frequently than not discover that the equilibrium wage is being bettered by firms, and is consistently holding that level. Why this rewarding of employees with higher than equilibrium wages persists is the basic question that Carl Shapiro and Joseph Stiglitz endeavour to answer in their paper “Equilibrium Unemployment as a worker discipline device.”
In attempting to answer this question Carl Shapiro and Joseph Stiglitz point out that we need to revert back to examing human nature itself, Humans will want to shirk as much work as possible.If they know they can get away with it then they will continue to shirk their work.Firms have to come up with a response to this problem they face of having workers know they can shirk putting in effort on the job. If an employee can be dismissed from a job and move directly into another one(as is this case when there is an equilibrium wage)then there is no case for an employee to fear being fired and thus can shirk as much as he likes.Therefore
only using dismissal as a worker discipline device proves futile in a perfectly competitive labour market.Unless offcourse there is fear that another job will prove difficult to obtain and will not be an imminent alternative.
Carl Shapiro and Joseph Stiglitz Develop a theory that produces some interesting and important implications:
1) Unemplyoment benefits increase the unemployment rate, Due to the fact that these benefits reduce the penalty of
being fired and in turn cause firms to pay higher wages to stop workers from shirking,Reducing the demand for labour.
2)Wages adjust slowly to aggregate shocks due to the fact that a wage decrease will rival a decrease in unemployment
which will be a slow process.
3)Market equilibrium is not pareto optimal.
Carl Shapiro and Joseph Stiglitz break up there model into three parts which i will summarise seperately:
1.The basic model
This consists of six components Workers, Their effort decisions, Employers, The prevailing market equilibrium, some
simple comparitive statistics, and Welfare analysis.
Assumptions in this model are that there is a fixed number of workers, who are identical and want to consume as many
goods as possible for minimum effort. Workers can exert in this model either minimal effort say = 0 or some fixed positive
effort = to greater than 0.When a worker is unemployed he exerts 0 effort and recieves unemplyoment benefits.
b)The effort decisions
Workers can chose how much effort they want to put it, If they chose to put in the minimum required to obtain their wage
then they will retain their jobs if not they will lose them. Simply put the worker needs to weigh up the utility obtained from
shirking against the utility gained from not shirking.
Here shapiro and stiglitz assume that there are M number of identical firms present and that each firm has a production
function Q =F(L) L is the firms effective labour force.For simplicity they assume that the workers either conributes one unit
of effective labour or none.Thus the firm bases its wage packet offering on this information.
d)The prevailing market equilibrium
This is where equilibrium wage and employment levels are produced by the model.Equilibrium occurs when each firm after
considering its position against other firms in the industry deciedes to offer the going wage rather than different one.
e)simple comparitive studies
Here shapiro and staglitz discuss the outcome of changing different parameters.E.G: Increasing the quit rate or decreasing the
monitoring intensity leads to decreasing incentives to exert effort by employees.
shapiro and staglitz demonstrate that equilibrium is not in general pareto optimal, when information cost are explicitly accounted
2.Extensions to the basic model
In this section of the article the two relax some of the assumptions they have made in the first section and how the results differ.
Three extensions are discussed:
This is wher employees themselves get to chose how much monitoring they want from their employers.i.e.higher wages mean
stricter wages and vice versa.This unnfortunately leads to to much monitoring and to high an equilibrium wage.Employers must now realise the only alternative to this intense monitoring will be a reduction in the size of employment.Leading to increased effort at work
due to threat of losing ones job and also decreasing the need for intense monitoring which is an unrealistic goal anyway.
Here the pair discuss that since the social optimum level of wages is greater than 0 if risk aversion is great enough, a justification for
mandatory minimum benefit levels being provided exists. Due to the fact that workers dont only lose their jobs dude to non effort but also dude to others factors such as job seperation.
Firms will always try and make their packages as anti labour turnover as possible since this leads to in the view of shapiro and stiglitz employees being less likely to shirk.
3.Alternative methods for the enforcement of discipline
Since this papers main aim was to discuss the effect of dismissing an employee as a discipline method and in shapiro and stiglitz view this is an effective method they deciede to briefly touch upon whether any other methods would be less costly or/and more effective to the market as a whole.
The first alternative method of discipline is performance bonds,Simply put a firm would revoke bonds given to an employee if a level of effort is not met. The downside to this is the firm will have it in its own interest to claim the worker didnt meet the level of effort required not to forfiet any bonds.Reputation alone cannot save the employer from being treated with suspicion by current and prospective employees because they have no way of telling whether or not a company dismissed an individual because they didnt exert enough effort or the person quit of his own accord.Also the fact that a quit could become a fire or vice versa quite easily makes this sort of discipline pretty uneffective.
The two point out that the assumption that people are identical is extremely unrealistic and this can be used by employers as a discipline tool.
Carl Shapiro and Joseph Stiglitz discuss unemplloyment as an incetive device.They stated that when it is costly to monitor individuals, competitive equilibrium wil be charecterized by unemployment.They point out that although the type of unemployment
discussed in this article is not the most important, it is a significant factor in the observed level of unemployment in lower skilled occupations.
I believe that Shapiro and Stiglitz display in this article assumptions most of us would come up with ourselves given time and effort, But on deeper investigation in many instances they show us that although most of us assume correctly with regards to these matters the reasons behind the actual assumptions are different.The pair provide great insight into the subject matter covered and few could argue agains the results there models have arrived at.At times though some of the assumptions that the models are based on themselves seem unrealistic, this however was dealt with quite nicely by the writers in the second section where they loosen up some of their assumptions showing flexibility in their models.