Existing theories of wage bargaining have paid only limited attention to labour-turnover costs, choosing instead to focus predominantly on how wages are set when the firm and its employees bargain without obstacle from other job-seekers. Alternatively, labour-turnover costs have usually been relegated to influencing the ‘external environment’ of the bargaining process. In Discussion Paper No. 1514, Paola Manzini and Dennis Snower argue that this approach fails to capture an extremely important phenomenon, namely that labour-turnover costs determine the firm’s degree of substitutability between two alternative sets of wage negotiations: (1) those the firm conducts with its incumbent employees (insiders); and (2) those it could conduct with other job-seekers (outsiders).

The authors provide an account of the sources of employees’ market power, and they examine the role of labour-turnover costs in the bargaining process. In addition, they examine why some firms ‘bond’ with their employees, i.e. enter into long-term relationships with them, whereas other firms have ‘revolving door’ relationships, characterized by short-term employment. They also investigate how wage bargaining can lead to unemployment that is ‘involuntary’, in the sense that outsiders remain jobless even though they would prefer employment to unemployment. In examining the role of labour-turnover costs in structuring the wage-bargaining process, the authors present a new theory of wage determination.

On the Foundations of Wage Bargaining
Paola Manzini and Dennis J Snower