Labour Markets
Insider dealings

If underbidding occurred whenever unemployed workers were willing to work for less than the prevailing wages, then involuntary unemployment would either disappear or would result in persistent wage deflation. Why does such underbidding not occur in labour markets? In Discussion Paper No. 196, Assar Lindbeck and Research Fellow Dennis Snower examine how cooperation or harassment by incumbent workers with market power ('insiders') may explain the absence of underbidding.

Lindbeck and Snower assume that insiders can choose whether or not to cooperate with newly hired employees in the process of production and whether or not to establish pleasant social relations with them. In order to preserve their jobs and maintain their wages, insiders may have an incentive to cooperate more with each other than with outsiders and to threaten to harass outsiders who are prepared to obtain jobs through underbidding. Thus, insiders are able to affect not only new employees' productivity, through cooperation in production, but also their disutility of work, through unfriendly attitudes or harassment. Such cooperation and harassment give the insiders a stronger bargaining position than the outsiders, who have no say in the process of wage negotiation. As a result insiders may succeed in raising their wages above the level at which outsiders would be willing to work, but firms nevertheless lack the incentive to replace insiders with outsiders or to add outsiders to their workforces.

The authors' analysis suggests that insiders' ability to withdraw cooperation or to harass outsiders may contribute to persistent involuntary unemployment. The wage negotiation process may yield an insider wage such that outsiders are involuntarily unemployed, yet firms may have no incentive to replace the insiders. Thus firms do not find it worthwhile to hire outsiders and the unemployment persists. By the same token, laid-off workers may not be able to retain their jobs by offering to work for lower wages. Lindbeck and Snower show that the remaining employees may find it advantageous to withdraw cooperation from the laid-off workers and thereby prevent them from regaining their jobs by underbidding.

This approach has important empirical implications, the authors argue: the size of the incumbent workforce may be an important determinant of the level of employment, since insiders may have market power over wages whereas outsiders do not.

Lindbeck and Snower also consider the effect of a change in business conditions on employment and wages. They find that the movement of wages and employment in an upswing and a downswing may not be symmetric. A downswing may be characterized by stable insider wages and a contraction of the incumbent workforce through retirements and lay-offs, while an upswing may take the form of rising insider wages and only modest increases in employment.

Cooperation, Harassment, and Involuntary Unemployment: An Insider-Outsider Approach
Assar Lindbeck and Dennis J Snower

Discussion Paper No. 196, July 1987 (ATE)