Fitting Equilibrium Search Models to Labor Market Data

The essential idea of equilibrium search models of labour market behaviour is that wage policy matters. In contrast, the stylized neoclassical competitive model predicts that firms paying a wage above the competitive equilibrium will disappear; those offering less will attract no workers. The search approach introduces "friction" via information asymmetries. Here, firms that offer high wages are more attractive to workers, obtaining and retaining employees more readily than firms offering lower wages. Other things equal high wage firms generate lower profit per worker but make it up on volume. These simple ideas about wage policy have been stated in informal ways by several scholars. Hicks (1932, [1966]) discusses the 'Gospel of High Wages' whereby unusually successful employers pay high wages to have the "pick of the market" (p.36). Kerr (1954) initiated a long-surviving, although never mainstream, line of research on empirical correlates of wage policy that has since become known as "Dual Labour Market" theory. While these early discussions of wage policy are often colorful, formal content has been given to the ideas only recently in equilibrium search models by Albrecht and Axell (1984), Burdett (1990), Burdett and Mortensen (1995), and Mortensen (1990). In competitive models wage policy doesn't matter because by definition in equilibrium the law of one price holds: all workers of a given type receive the same wage. Even in simple monopsony models of the labour market (Card and Krueger (1995)) wage policy does not matter because the law of one price still holds, albeit at lower than the competitive level. In contrast, search models generate dynamic monopsony power for employers due to the presence of frictions such as the length of time it takes to find a new job. A firm's wage policy is important in such models because it directly affects the distribution of income in an economy. Moreover in such dynamic monopsony models public policy experiments such as introducing or changing a minimum wage can have employment effects that are quite different from those expected in the standard competitive case.