On the Efficiency of Wage-Setting Mechanisms with Search Frictions and Human Capital Investment∗

A challenge facing labor economists is to explain the existence of different wage-setting mechanisms. This paper investigates the relative efficiency of competitive wage, wage bargaining and wage posting. In a search-theoretical model with human capital investment we establish the conditions, which are associated to the cost structures of human capital investment and job vacancy creation, for one of them to prevail. The insight is that a mechanism generates the highest level of equilibrium welfare by achieving the best balance between aggregate output and aggregate cost. Moreover, we find under the Hosios condition and for a broad range of cost parameter values that: if workers’ matching contribution is sufficiently larger than their output contribution, then wage posting prevails; if their output contribution is sufficiently larger than their matching contribution, then wage bargaining prevails; if the two contributions are sufficiently close to each other, then competitive wage prevails. These findings justify the survey evidence reported by Hall and Krueger (2012).