Long-Term Contracts and Equilibrium Models of the Labor Market: Some Favorable Evidence

Abstract

In this paper we develop and test a very general implication of competitive contractual arrangements in the labor market. Toward this end we examine whether the level of unemployment prevailing at the beginning of the job has lasting effects on wage payments throughout the job. The intuition behind this test is straightforward. If the labor market functions as a competitive contracting market, then it is the supply and demand conditions at the time of negotiating the contract that determine the wage provisions of the contract. Using data from the Current Population Survey (CPS) and the Panel Study of Income Dynamics (PSID) we find that wages strongly depend on the labor market conditions prevailing at the beginning of one’s job. Moreover, our results indicate that the value of new employment contracts varies by approximately l0 percent over the business cycle.