Hidden effort, learning by doing, and wage dynamics

Many occupations are subject to learning by doing: Effort at the workplace early in the career of a worker results in higher productivity later on. In such occupations, if effort at work is unobservable, a moral hazard problem also arises. We study a particular specification of learning by doing in which the conditional distribution of output depends on the sum of undepreciated efforts. With this specification, we can overcome the technical difficulties for solving for the optimal contract that arise because of the persistent effects of effort in time. Our numerical example shows that effort is frontloaded over the contractual relationship, and follows a steeper decreasing pattern than in the case without learning by doing. On the other hand, the properties of wage dynamics remain unchanged with respect to those of the optimal contract without learning by doing.