Efficiency Wage, Fixed Employment Costs, and Dual Labour Markets

The standard efficiency wage-based explanation of labour market dualism hinges on the existence of differences in monitoring across sectors. The paper proposes fixed employment costs as an alternative source of wage differentials for homogeneous workers. It shows that firms with larger fixed costs pay higher wages in order to elicit more effort from their workers, and tend to have higher capital/labour ratio and labour productivity. The model generates both involuntary unemployment and involuntary confinement in the secondary sector: high effort–high wage jobs are preferred to low effort–low wage jobs and either are preferred to unemployment. The proposed framework can also account for the various types of treatment of marginal jobs in primary sector firms envisaged by Doeringer and Piore (Internal Labour Markets and Manpower Analysis, 1971). In particular, an increase in fixed costs beyond a certain level may induce primary sector firms to restructure, segment production, and enter the secondary sector, thus converting their jobs into secondary jobs. From a welfare point of view, we cannot state in general the desirability of subsidizing fixed employment costs; however, we show that an employment subsidy financed by a wage tax is able to increase employment with no loss in terms of production.