DP4193 Labour Market Frictions, Job Insecurity and the Flexibility of the Employment Relationship

Author(s): Niko Matouschek, Paolo Ramezzana, Frédéric Robert-Nicoud
Publication Date: January 2004
Keyword(s): flexibility of employment relationships, job insecurity, private information
JEL(s): D82, J41
Programme Areas: Labour Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=4193

We analyse a search model of the labour market in which firms and workers meet bilaterally and negotiate over wages in the presence of private information. We show that a fall in labour market frictions induces more aggressive wage bargaining behaviour, which in turn leads to a costly increase in job insecurity. This adverse insecurity effect can be so large that firms and workers who are in an employment relationship can be made worse off by a fall in labour market frictions. In contrast, firms and workers who are not in an employment relationship and are searching the market for a counterpart are always made better off by such a fall in labour market frictions. We then endogenize the organizational structure of the employment relationship and show that a fall in labour market frictions induces a one-off reorganization in which firms and workers switch from a rigid employment relationship to a flexible one. This reorganization leads to a large, one-off increase in job insecurity and unemployment.