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A Theory of Wage Dynamics

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  • Milton Harris
  • Bengt Holmstrom

Abstract

A dynamic, equilibrium model of long term (implicit) labour contracts under incomplete but symmetric information is developed. Workers are assumed to be risk averse and of unknown ability or productivity. Risk neutral firms learn, as do workers, about each worker's productivity by observing the worker's output over time. It is shown that equilibrium contracts provide for wages which never decline with age and increase only when the worker's market value increases above his current wage. In addition to characterizing the equilibrium wage contract, we also derive some of its implications for the behaviour of aggregate wages across various groups of workers. These implications explain some findings in the recent empirical literature on age-earnings profiles. In particular our model can explain why earnings may be positively related to experience even after controlling for productivity, as some empirical studies have indicated.
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Suggested Citation

  • Milton Harris & Bengt Holmstrom, 1981. "A Theory of Wage Dynamics," Discussion Papers 488, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    • Handle: RePEc:nwu:cmsems:488
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    References listed on IDEAS

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    Cited by:

    1. Barrett, Christopher B. & Bailey, DeeVon, 1999. "Are Agricultural Experiment Station Faculty Salaries Competitively Or Monopsonistically Determined?," Agricultural and Resource Economics Review, Northeastern Agricultural and Resource Economics Association, vol. 28(1), pages 1-10, April.
    2. Charles T. Carlstrom, 1989. "Turnover, wages, and adverse selection," Economic Review, Federal Reserve Bank of Cleveland, vol. 25(Q I), pages 18-28.
    3. Robert Gibbons & Lawrence F. Katz & Thomas Lemieux & Daniel Parent, 2005. "Comparative Advantage, Learning, and Sectoral Wage Determination," Journal of Labor Economics, University of Chicago Press, vol. 23(4), pages 681-724, October.
    4. Waldman, Michael, 1990. "Up-or-Out Contracts: A Signaling Perspective," Journal of Labor Economics, University of Chicago Press, vol. 8(2), pages 230-250, April.
    5. Paul Oyer, 2000. "Why Do Firms Use Incentives that Have No Incentive Effects?," Econometric Society World Congress 2000 Contributed Papers 1440, Econometric Society.
    6. David N. Margolis, 1996. "Cohort Effects and Returns to Seniority in France," Annals of Economics and Statistics, GENES, issue 41-42, pages 443-464.
    7. Michael Waldman, 2012. "Theory and Evidence in Internal LaborMarkets [The Handbook of Organizational Economics]," Introductory Chapters,, Princeton University Press.
    8. Nicola Cetorelli & Pietro F. Peretto, 2000. "Oligopoly banking and capital accumulation," Working Paper Series WP-00-12, Federal Reserve Bank of Chicago.
    9. Robert Plasman & François Rycx & Ilan Tojerow, 2006. "Industry wage differentials, unobserved ability, and rent-sharing : Evidence from matched worker-firm data, 1995-2002," Working Paper Research 90, National Bank of Belgium.
    10. Marianne Bertrand, 2004. "From the Invisible Handshake to the Invisible Hand? How Import Competition Changes the Employment Relationship," Journal of Labor Economics, University of Chicago Press, vol. 22(4), pages 723-766, October.
    11. John Haltiwanger & Michael Waldman, 1984. "Insurance Aspects of Labor Market Contracting: An Overview," UCLA Economics Working Papers 348, UCLA Department of Economics.
    12. Haltiwanger, John & Waldman, Michael, 1986. "Insurance and Labor Market Contracting: An Analysis of the Capital Market Assumption," Journal of Labor Economics, University of Chicago Press, vol. 4(3), pages 355-375, July.
    13. Lustig, Hanno & Syverson, Chad & Van Nieuwerburgh, Stijn, 2011. "Technological change and the growing inequality in managerial compensation," Journal of Financial Economics, Elsevier, vol. 99(3), pages 601-627, March.
    14. Miguel Portela & Ana Rute Cardoso, 2005. "The provision of wage insurance by the firm: evidence from a longitudinal matched employer-employee dataset," NIPE Working Papers 17/2005, NIPE - Universidade do Minho.
    15. Waldman, Michael, 1989. "Information on worker ability : An analysis of investment within the firm," Information Economics and Policy, Elsevier, vol. 4(1), pages 57-80.
    16. David Neumark, 1992. "Are Rising Wage Profiles a Forced-Saving Mechanism?," NBER Working Papers 4213, National Bureau of Economic Research, Inc.
    17. Tomas Philipson & George Zanjani, 1997. "Consumption vs. Production of Insurance," NBER Working Papers 6225, National Bureau of Economic Research, Inc.
    18. Michael Waldman, 1984. "Job Assignments, Signalling, and Efficiency," RAND Journal of Economics, The RAND Corporation, vol. 15(2), pages 255-267, Summer.
    19. Blackburn, McKinley L & Neumark, David, 1993. "Omitted-Ability Bias and the Increase in the Return to Schooling," Journal of Labor Economics, University of Chicago Press, vol. 11(3), pages 521-544, July.
    20. Bengt Holmstrom & I. Ricard & Joan Costa, 1984. "Managerial Incentives and Capital Management," Cowles Foundation Discussion Papers 729, Cowles Foundation for Research in Economics, Yale University.
    21. Joan E. Ricarti Costa, 1984. "Managerial Task Assignment and Promotions," Discussion Papers 595S, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    22. Espen Eckbo, B. & Thorburn, Karin S., 2003. "Control benefits and CEO discipline in automatic bankruptcy auctions," Journal of Financial Economics, Elsevier, vol. 69(1), pages 227-258, July.
    23. Robert Gibbons & Michael Waldman, 1998. "A Theory of Wage and Promotion Dynamics in Internal Labor Markets," NBER Working Papers 6454, National Bureau of Economic Research, Inc.
    24. Joseph G. Altonji & Nicolas Williams, 1992. "The Effects of Labor Market Experience, Job Seniority, and Job Mobility on Wage Growth," NBER Working Papers 4133, National Bureau of Economic Research, Inc.
    25. John Haltiwanger & Michael Waldman, 1983. "Why Bad Wokers Receive Raises," UCLA Economics Working Papers 301, UCLA Department of Economics.

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