The macroeconomic implications of turnover costs and wage contracts

In a labour market characterised by linear turnover costs in employment, the hold-up issue may arise and firms may invest inefficiently. This paper introduces hiring and firing costs in a dynamic general equilibrium, and analyses the effects of two different contractual arrangements, employment at will and fixed wage contracts, that both ensure efficient investment and employment decisions. While the arrangements have different implications for wage dynamics, they imply identical employment and investment allocations due to their efficiency properties. The model replicates the dynamic behaviour of US labour market variables, including measures for hiring and firing. In terms of aggregate wage statistics, both contractual arrangements generate near zero correlation between the average wage and output, and dampen the fluctuations in the average wages, but can be distinguished by the implied distributions of wage changes. Only the fixed wage contract generates a spike at zero wage changes for job stayers, in accordance with recent empirical evidence.