Wage bargaining and turnover costs with heterogeneous labor and asymmetric information

We study a model of individual wage bargaining between heterogeneous workers and firms, with instantaneous matching, free firm entry, workers’ individual productivities are discovered by firms only after being hired, and it is expensive for firms to hire and fire workers. We show that inefficiencies due to bargaining and externalities in the matching process lead firms to employ too few worker types. Employment among employed worker types is also inefficiently low when workers have high bargaining power, but may be too high when workers’ bargaining power is low. The government can correct these inefficiencies by reducing or increasing firms’ hiring and firing costs. This implies that the costs of firing tenured workers ‘almost always’ should be reduced. We argue that the model gives a good description of recent labor market phenomena in advanced economies. q 2000 Elsevier Science B.V. All rights reserved.