Good Jobs versus Bad Jobs

Daron Acemoglu,
Massachusetts Institute of Technology

This article develops a model of noncompetitive labor markets in which high-wage (good) and low-wage (bad) jobs coexist. Minimum wages and unemployment benets shift the composition of employment toward high-wage jobs. Because the composition of jobs in the laissez-faire equilibrium is inefciently biased toward low-wage jobs, these labor market regulations increase average labor productivity and may improve welfare. I. Introduction The current debate on labor market regulations focuses on their effects on the level of employment. This article argues that these measures may have a rst-order impact on the composition of employment as well as the number of jobs. I show that in a standard model of the labor market, unemployment insurance and minimum wages induce rms to create more high-wage jobs, increase average labor productivity, and may improve welfare. Similar points have been made informally. Unions, for example, often support minimum wages and other regulations, arguing that they will improve the quality of jobs (see, e.g., Harrison and Blue-

This is the theory part of a previous study entitled Good Jobs versus Bad Jobs: Theory and Some Evidence. I thank Josh Angrist, Olivier Blanchard, Ricardo Caballero, Peter Diamond, David Genesove, Jonathan Gruber, Alan Krueger, Steve Pischke, Jaume Ventura, and seminar participants at the European University Institute in Florence, the Centre for Economic Policy Research Rising Inequalities Conference, the National Bureau of Economic Research Summer Institute, Massachusetts Institute of Technology, Princeton, and SUNY Albany for useful comments and suggestions. Financial support from the World Economic Laboratory at the Massachusetts Institute of Technology and National Science Foundation grant SBR-9602116 are gratefully acknowledged.
[ Journal of Labor Economics, 2001, vol. 19, no. 1] 2001 by The University of Chicago. All rights reserved. 0734-306X/2001/1901-0001$02.50

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stone 1988). This article demonstrates that some of these claims, perhaps in a less extreme form, follow from standard economic models. I develop a simple extension of the standard search model of Diamond (1982), Mortensen (1982), and Pissarides (1990) with two different types of jobs. In the model economy, wage differentials for homogeneous workers emerge because different types of jobs have different creation (capital) costs.1 Search frictions break the link between marginal product and wages, and they introduce rent-sharing between rms and workers. Although in many search models, an appropriate division of bargaining power can internalize the pecuniary externalities from rent-sharing (e.g., Hosios 1990a; Pissarides 1990), in the unregulated (laissez-faire) equilibrium of this economy, the composition of jobs is always inefciently biased toward low-wage jobs. The reason for this inefciency is a form of hold-up. A rm with a capital-intensive job, which has already sunk its more expensive investment, is forced to bargain to a higher wage and creates a greater positive (pecuniary) externality on workers. Since rms do not internalize this effect, they open too few high-wage and too many low-wage jobs. The more novel results of this framework concern the impact of labor market regulations on the composition of jobs, labor productivity, and welfare. With higher unemployment benets, waiting for high-wage jobs is less costly, so some workers who would have otherwise accepted low-wage jobs wait for high-wage (good) jobs.2 This change in search behavior induces more good jobs to be created. There is also an indirect general equilibrium effect: as more good jobs are created, the value of being unemployed increases because workers anticipate a higher probability of getting a high-wage job and they become even less willing to accept bad jobs. The minimum wage has the same overall effect but works somewhat differently. A binding minimum wage increases the wage that bad jobs have to pay, which makes them less protable and improves the composition of jobs. Both minimum wages and unemployment insurance increase labor productivity because they shift employment toward more cap-

1 In the data, there are large and stable wage differentials among observationally identical workers in different industries and occupations (see Krueger and Summers 1987, 1988). Workers who change industry appear to receive the wage differential between their previous and new job (Krueger and Summers 1988; Gibbons and Katz 1992), and high-wage jobs have lower quit rates (Krueger and Summers 1988) and longer worker queues (Holzer, Katz, and Krueger 1991). As in this model, high-wage industries and jobs are on average more capital intensive (Dickens and Katz 1987). 2 I refer to high-wage jobs as good, especially since in equilibrium there will be too few of these jobs. This does not imply that it is always welfare improving to have more high-wage jobs.

Good Jobs versus Bad Jobs

ital-intensive good jobs. Since there are too few good jobs in the laissez-faire equilibrium, these labor market regulations may even improve welfare. The general equilibrium effects can also lead to multiple equilibria with different compositions of jobs. In one equilibrium, there are many good jobs, so the outside option of workers is high and bad jobs can only employ them by paying relatively high wages. This makes bad jobs unprotable. In the other equilibrium, there are many bad jobs, so the outside option of workers is low. The resulting low wages encourage entry and increase labor market tightness and vacancy duration. Because good jobs have larger upfront investments, a tighter labor market hurts them more and encourages the creation of bad jobs. A number of studies are related to this work. First, as noted above, I build on the search models of Diamond (1982), Mortensen (1982), and Pissarides (1990). However, in contrast with these contributions, I analyze a search model with an endogenous distribution of jobs (see also Davis 1995; and Acemoglu 1996, 1997, 1999), and I emphasize the distortions in the composition of jobs arising from a version of the holdup problem (Grout 1984). Pissarides (1994) also analyzes an economy with heterogeneous jobs, but his focus is the modelling of on-the-job-search in the standard search setup. None of these papers discusses the impact of labor market regulation on the composition of jobs, which is the main focus of this article. Diamond (1981), Acemoglu and Shimer (1999a), and Marimon and Zilibotti (1999) also consider models in which unemployment benets may improve welfare, but for reasons different from those we consider here. The inuential paper by Burdett and Mortensen (1989) demonstrates that minimum wages may increase employment, while Lang (1987) shows that when there is signaling in the labor market, a minimum wage law may discourage low-ability workers from imitating high-ability workers and increase welfare. Most closely related to the current studys perspective are previous multisector labor market models with frictions. Bulow and Summers (1986) construct a two-sector efciency wage model. Davidson, Martin, and Matusz (1987, 1988) and Hosios (1990b) construct two-sector search models where the equilibrium may be inefcient due to standard search inefciencies, which is different from the hold-up inefciency explored in this article. None of these studies (except in part Acemoglu and Shimer 1999a) shares the result that minimum wages and unemployment insurance improve the composition of jobs, since this feature crucially relies on search and on the heterogeneity of jobs. The remainder of this article is organized as follows. Section II analyzes the basic model. It determines the equilibrium composition of jobs and

Acemoglu

exposes the link between labor market regulation and the mix of jobs. Section III considers some extensions. II. The Basic Model A. Technology and Preferences Labor and capital are used to produce two nonstorable intermediate goods that are then sold in a competitive market and immediately transformed into the nal consumption good. Preferences of all agents are dened over the nal consumption good alone. Throughout the article, I will normalize the price of the nal good to 1. There is a continuum of identical workers with measure normalized to 1. All workers are innitely lived and risk neutral.3 They derive utility from the consumption of the unique nal good and maximize the present discounted value of their utility. Time is continuous, and the discount rate of workers is equal to r. On the other side of the market, there is a larger continuum of rms that are also risk neutral, with discount rate r. The technology of production for the nal good is
1/ Y Y b 1 Y g ,

(1)

where Y g is the aggregate production of the rst input, Y b is the aggregate production of the second input, and 1. The elasticity of substitution between Y g and Y b is 1/(1 ), and parameterizes the relative importance of Y b . The reason for the use of the subscripts g and b will become clear shortly. This formulation captures the idea that there is some need for diversity in overall consumption-production, and it is also equivalent to assuming that equation (1) is the utility function dened over the two goods. Since the two intermediate goods are sold in competitive markets, their prices are
1 1 pb Yb Y , 1 1 p g 1 Y g Y .

(2) (3)

The technology of production for the inputs is Leontieff. When matched with a rm with the necessary equipment (capital k b or k g ), a worker
3 The assumption that workers are risk neutral obviously leaves out the most important role of unemployment insurance, but it also helps to highlight that the impact of unemployment benets on job composition is distinct from their insurance role. See Acemoglu and Shimer (1999a) for a model of search and risk aversion.

Good Jobs versus Bad Jobs

produces one unit of the respective good.4 The equipment required to produce the rst input costs k g , while the cost of equipment for the second input is k b . Throughout this article, I assume that k g k b . Before we move to the search economy, it is useful to consider the perfectly competitive benchmark. Since k g k b , in equilibrium, we will have p g p b . But rms hire workers at the common wage, w, irrespective of their sector. Thus, there will be neither wage differences nor bad nor good jobs. Also, since the rst welfare theorem applies to this economy, the composition of output will be optimal. B. Search: The Main Idea Before presenting the detailed analysis, I will heuristically describe the main result. As soon as we enter the world of search, there will be some rent sharing. This implies that a worker who produces a higher-valued output will receive a higher wage. As noted above, because k g k b , the input that costs more to produce will command a higher price; thus, in equilibrium, p g p b . Rent-sharing, then, leads to equilibrium wage differentials across identical workers. That is, w g w b . Hence, the terms good job and bad job. Next, it is intuitive that since, as compared with the economy with competitive labor markets, good jobs have higher relative labor costs, their relative production will be less than optimal. In other words, the proportion of good (high-wage) jobs will be too low as compared with what a social planner would choose. The rest of this section will formally analyze the search economy and establish these claims. It will then demonstrate that higher minimum wages and more generous unemployment benets will improve the composition of jobs and possibly improve welfare. C. The Technology of Search Firms and workers come together via a matching technology M ( u , v ) where u is the unemployment rate, and v is the vacancy rate (the number of vacancies). The underlying assumption here is that search is undirected; thus both types of vacancies have the same probability of meeting workers, and it is the total number of vacancies that enters the matching function. Section IIB allows for directed search, whereby workers decide for which type of job to apply. The function M ( u , v ) is twice differentiable and increasing in its arguments, and it exhibits constant returns to scale. This enables me to write the ow rate of match for a vacancy as M ( u , v )/ v q ( ), where q is a differentiable decreasing function, and

4 Since utility is linear, whether we think of k b and k g as capital costs or not is immaterial. The assumption that one worker and equipment k i produce one unit of the corresponding intermediate good is a convenient normalization.

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v / u is the tightness of the labor market. It also immediately follows from the constant returns to scale assumption that the ow rate of match for an unemployed worker is M ( u , v )/ u q ( ) (see Pissarides 1990). In general, q ( ), q ( ) ; thus it takes time for workers and rms to nd suitable production partners. I also make the standard Inada-type assumptions on M ( u , v ), which ensure that q ( ) is increasing in and that lim3 q ( ) 0, lim30 q ( ) , lim3 q ( ) 0, and lim30 q( ) . All jobs end at the exogenous ow rate s, and in this case, the rm becomes an unlled vacancy and the worker becomes unemployed. Finally, there is free entry into both good-job and bad-job vacancies; therefore, both types of vacancies should expect zero net prots. I denote the ow return from unemployment by z, which will be thought as the level of unemployment benet nanced by lump-sum taxation.5 I assume that wages are determined by asymmetric Nash bargaining, where the worker has bargaining power (see Pissarides 1990). Nash bargaining per se is not essential, though rent sharing is crucial for the results. Firms can choose either one of two types of vacancies: (i) a vacancy for an intermediate good 1a good job or (ii) a vacancy for an intermediate good 2a bad job. Therefore, before opening a vacancy, a rm has to decide which input it will produce, and at this point, it will have to buy the equipment that costs either k b or k g . The important aspect is that these creation costs are incurred before the rm meets its employees. This is a reasonable assumption, since, in practice, k corresponds to the costs of machinery, which are sector and occupation specic. D. The Basic Bellman Equations I will solve the model via a series of Bellman equations. I denote the discounted value of a vacancy by J V , of a lled job by J F , of being unemployed by J U , and of being employed by J E . I will use subscripts b and g to denote good and bad jobs. I also denote the proportion of bad-job vacancies among all vacancies by . Then, in steady state,
E E rJ U z q J b 1 J g J U .

(4)

5 Naturally, unemployment insurance and assistance in the real world do not take this simple form (see, e.g., Atkinson and Micklewright 1991). First, benets depend on past employment history and earnings (see Sec. IIIC on this); second, unemployment benets typically expire after a while; and third, there are additional eligibility requirements. Including these complications will not change the main qualitative implications of the analysis (see Mortensen 1977 for a detailed partial equilibrium analysis of the impact of unemployment insurance on search decisions).

Good Jobs versus Bad Jobs

Since this type of equation is rather standard (e.g., Pissarides 1990), I will only give a brief explanation. Being unemployed is similar to holding an asset. This asset pays a dividend of z, the unemployment benet, and it has a probability q ( ) of being transformed into a bad job, in which E case the worker obtains J b , the asset value of being employed in a bad job, U and loses J . It also has a probability q ( )(1 ) of being transformed U U into a good job, yielding a capital gain J E g J (out of steady state, J has to be added to the right-hand side to capture future changes in the value of unemployment). Observe that this equation is written under the implicit assumption that workers will not turn down jobs, which I will discuss further below (see n. 6). The steady-state discounted present value of employment can be written as
E U rJ E i wi s J Ji ,

(5)

for i b, g. Equation (5) has an intuition similar to that of equation (4). Similarly, when matched, both vacancies produce one unit of their goods, so
V F rJ F i pi wi s Ji Ji , F V rJ V i q J i J i ,

(6) (7)

for i b, g, where I have ignored the possibility of voluntary job destruction, which will never take place in a steady state. Since workers and rms are risk neutral and have the same discount rate, Nash bargaining implies that w b and w g will be chosen so that
E F V 1 J b J U J b Jb , E F V 1 J g J U J g Jg .

(8)

Note that an important feature is already incorporated in these expressions: workers cannot pay to be employed in high-wage jobs; due to search frictions, at the moment a worker nds a job, there is bilateral monopoly, and this leads to rent sharing over the surplus of the match. As there is free entry on the rm side, it should not be possible for an additional vacancy to open and make expected net prots. Hence JV i ki . (9)

Finally, the steady-state unemployment rate is given by equating ows out of unemployment to the number of destroyed jobs. Thus

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s . s q

(10)

E. Characterization of Steady-State Equilibria A steady-state equilibrium is dened as a proportion of of bad jobs; V F E F E tightness of the labor market ; value functions J b , Jb , Jb , JV g , J g , J g , and U J ; prices for the two goods, p b and p g , such that equations (2), (3), (4), (5), (6), (7), (8), and (9) for both i b and g are satised. The steady-state unemployment rate is then given by equation (10).6 In steady state, both types of vacancies meet workers at the same rate, and in equilibrium workers accept both types of jobs; therefore Y b (1 u ) , and Y g (1 u )(1 ). Then, from equation (3), the prices of the two inputs can be written as p g 1 1 1 1 1 p b
1 1

1 1

(11)

Using equations (5), (6), (8), and (9), simple algebra gives w i p i rk i 1 rJ U (12)

as the wage equation. Intuitively, the surplus that the rm gets is equal to the value of output, which is p i minus the ow cost of the equipment, rk i . The worker gets a share of this, plus (1 ) times his outside option, rJ U . Using equations (6) and (7), the zero-prot condition, equation (9), can be rewritten as q 1 p b rJ U rk b, r s 1 q q 1 p g rJ U rk g. r s 1 q (13)

(14)

A rm buys equipment that costs k i , which remains idle for a while due to search frictions (i.e., because q ( ) ). This cost is larger for rms that buy more expensive equipment and open good jobs. They need to

6 One might wonder at this point whether a different type of equilibrium, with E JU Jb and workers accepting bad jobs with probability 1, could exist. The V F answer is no. From eq. (8), this would imply J b Jb , but in this case, rms could never recover their upfront investment costs.

Good Jobs versus Bad Jobs

recover these costs in the form of higher net ow prots, that is, p g rk g p b rk b . From rent sharing, this immediately implies that w g w b . More specically, combining equations (12), (13), and (14), we get wg wb r s rk g rk b 0. q (15)

Therefore, wage differences are related to the differences in capital costs and also to the average duration of a vacancy. In particular, when q ( ) 3 , the equilibrium converges to the Walrasian limit point and both w g and w b converge to rJ U , so wage differences disappear. The reason for this is that in this limit point, capital investments never remain idle; thus good jobs do not need to make higher net ow prots. Also, with equal creation costs, that is, with k b k g , wage differentials disappear again. Finally, equation (4) gives the value of an unemployed worker as rJ U G , r s z q p b rk b 1 p g rk g . r s q (16)

It can easily be veried that G ( , ) is continuous, strictly increasing in , and strictly decreasing in . Intuitively, as the tightness of the labor market, , increases, workers nd jobs faster; thus rJ U is higher. Also as decreases, the greater fraction of good jobs among vacancies increases E the value of being unemployed, since w g w b (i.e., J V g J b ). The U dependence of rJ on is the general equilibrium effect mentioned in the introduction: as the composition of jobs changes, the option value of being unemployed also changes. A steady-state equilibrium is characterized by the intersection of two loci: the bad-job locus equation (13) and the good-job locus equation (14) (both evaluated with eqq. (11) and (16) substituted in). Figure 1 draws these two loci in the - plane. Locus (14), along which a rm that opens a good-job vacancy makes zero-prots, is upward sloping: a higher value of increases the left-hand side of equation 14; thus needs to change to increase the right-hand side (and to reduce the left-hand side through G ( , )). Intuitively, an increase in implies a higher p g (from eq. [11]). So, to ensure zero prots, needs to increase to raise the duration of vacancies. In contrast, locus (13) cannot be shown to be decreasing everywhere. Intuitively, an increase in reduces p b , and thus it requires a fall in to equilibrate the market, but the general equilibrium effect through J U (i.e., that a fall in reduces J U ) counteracts this and may dominate. This issue is discussed further in the next subsection.

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FIG. 1.Equilibrium determination

Here, I start with the case in which 0, so that good jobs and bad jobs are gross complements. In this case, it is straightforward to see that as tends to 1, equation (13) gives 3 , whereas equation (14) implies 3 0. Thus, the bad-job locus is above the good-job locus. The opposite is the case as goes to 0. Then, by the continuity of the two functions, they must intersect at least once in the range (0, 1). The following proposition summarizes these results. PROPOSITION 1. Suppose that 0. Then, a steady state equilibrium with (0, 1) always exists and is characterized by equations (11), (12), (13), (14), and (16). In equilibrium, for all k g k b , we have p g p b , and w g w b. When 0, an equilibrium continues to exist, but it does not need to be interior, so one of equation (13) and (14) may not hold. A particular example of this is discussed in the next subsection. F. Multiple Equilibria Since locus (13) can be upward sloping over some range, more than one intersection, and hence multiple equilibria, are possible. Locus (13) is more likely to be upward sloping when relative prices change little as a result of a change in the composition of jobs. Therefore, to illustrate the possibility of multiple equilibria, I consider the extreme case where 1, so that goods g and b are perfect substitutes and there are no relative price

Good Jobs versus Bad Jobs

11

effects. Furthermore, I assume that 1 2 r ( k g k b ). In the absence of this assumption, good jobs are not productive enough, and they will never exist in equilibrium. The absence of substitution between good jobs and bad jobs immediately implies that p g 1 p b . The equilibrium can then be characterized diagrammatically. To do this, totally differentiate equations (13) and (14), with p g 1 , and p b , which gives G , d d i G , r s 1 q ki 1 q 2

G ,

0,

(17)

where i b is the zero-prot condition for bad jobs (eq. 13), and i g is the zero-prot condition for good jobs (eq. 14). The derivative in equation (17) is positive, irrespective of whether it is for good jobs or bad jobs, because rJ U G ( , ) is decreasing in and increasing in , while q ( ) 0. Since k b k g , this equation also immediately implies that locus (13) is steeper than locus (14). So locus (13) has to intersect locus (14) from below, if at all, in which case there will be three equilibria, as shown in gure 2.7 The rst is a mixed strategy equilibrium at the point where the two curves intersect. The other two equilibria are more interesting. When 0, we have g b , so that it is more protable to open a good job (see g. 2).8 Hence, there is an equilibrium in which all rms open good jobs. It is not protable for rms to open a bad job, because when 0, workers receive high wages and have attractive outside options; so a rm that opens a bad job will be forced to pay a relatively high wage, making a deviation to a bad job unprotable. In contrast, at 1, we have g b , so it is an equilibrium for all rms to open bad jobs. Intuitively, when all rms open bad jobs, the outside option of workers is low, so rms bargain to low wages, making entry relatively protable. In equilibrium, has to be high to ensure zero prots. But a tight labor market (a high ) hurts good jobs relatively more since they have to make larger upfront investments. The multiplicity of equilibria in this model illustrates the strength of the general equilibrium forces that

7 Alternatively, the two curves may never intersect. In this case, if b g and b g , then the unique equilibrium is one with bad jobs only, or if b g and b g , there will only be good jobs. 8 Firms that open good jobs make zero prots at g , while rms that open bad jobs make zero prot at b . Since g b , good jobs are more protable than bad jobs.

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FIG. 2.Multiple equilibria

operate through the impact of job composition on the overall level of wages. G. Welfare To analyze the welfare properties of equilibrium, I look at the total steady-state surplus of the economy, dened as total output minus total costs, that is, the net output of the economy. This measure is what an agent would care about before entering the economy (as is the convention in these models; see Hosios 1990a; Pissarides 1990). Total surplus (in steady state) can be written as TS 1 u p b rk b 1 p g rk g u rk b 1 rk g . (18)

Total surplus is equal to total ow of net output, which consists of the number of workers in good jobs [(1 )(1 u )] times their net output ( p g minus the ow cost of capital rk g ), plus the number of workers in bad jobs [ (1 u )] times their net product ( p b rk b ), minus the ow costs of job creation for good and bad vacancies (respectively, u (1 ) rk g and u rk b ). It is straightforward to locate the set of allocations that maximize total

Good Jobs versus Bad Jobs

13

social surplus. This set would be the solution to the maximization of equation (18) subject to equation (10). Inspecting the rst-order conditions of this problem, it can be seen that decentralized equilibria will not in general belong to this set; thus a social planner can improve over the equilibrium allocation. The results regarding the socially optimal amount of job creation are standard (Hosios 1990a; Pissarides 1990): if is too high, that is () (where () is elasticity of the matching function, q ( )), then there will be too little job creation; if (), there will be too much. Since this article is concerned with the composition of jobs, I will not discuss these issues in detail. Instead, I will show that regardless of the value of , the equilibrium value of is always too high; that is, there are too many bad jobs relative to the number of good jobs. To prove this claim, it is sufcient to consider the derivative of TS with respect to at z 0 (note that the constraint, eq. [10], does not depend on ): d TS d p b 1 p g 1 u 1 u u rk b rk g . d d (19) For the composition of jobs to be efcient at the laissez-faire equilibrium, equation (19) needs to equal zero when evaluated in the equilibrium characterized above. Some simple algebra (details are available on request) using equations (10), (11), (13), and (14) to substitute out u, and k i gives: d TS d

dec.eq.

q s q 1 1 p b p g 0. s q r s 1 q

This expression is always negative, regardless of the value of ; so starting from laissez-faire equilibrium, a reduction in will increase social surplus. Therefore: PROPOSITION 2. Let s ( ) be the value of that the social planner would choose at labor market tightness , and let *() be the laissez-faire equilibrium with z 0; then *( ) s ( ) for all . That is, in the laissez-faire equilibrium, the proportion of bad jobs is too high. The intuition is simple; in a decentralized equilibrium, it is always the case that w g w b . Yet, rms do not take into account the higher utility they provide to workers by creating a good job rather than a bad job; hence, there is an uninternalized positive externality, which leads to an excessively high fraction of bad jobs in equilibrium. Search and rent sharing are crucial for this result. Search ensures that rms have to share the ex post rents with the workers and that they cannot induce competition among workers to bid down wages. Firms would ideally like to contract with their workers on the wage rate before they make the

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investment decision, but search also implies that the rms do not know who these workers will be, and thus cannot contract with them at the time of investment (Acemoglu 1996). H. The Impact of Minimum Wages and Unemployment Benets As is usual in models with potential multiple equilibria, only the comparative statics of extremal equilibria are of interest. Therefore, I assume in this subsection that the economy is in an equilibrium where locus (14) cuts locus (13) from below.9 Now consider an increase in z, which corresponds to the unemployment insurance system becoming more generous. Both the bad-job locus (eq. [13]) and the good-job locus (eq. [14]) will shift down (to the dotted curves in g. 1). Hence, will denitely fall. It is also straightforward to verify that (13) will shift by more; therefore, is unambiguously reduced.10 Intuitively, with unchanged, relative prices and hence wages will be unchanged, but then with the higher unemployment benets, workers would prefer to wait for good jobs rather than accept bad jobs. This increases w b and reduces (the fraction of bad jobs). Furthermore, a more generous unemployment benet not only increases the fraction of good jobs, but it may also increase the total number of good jobs. Totally differentiating equations (13) and (14), we obtain that the total number of good jobs will increase if and only if wg wb

1 d p g p b 1 u 1 , d

where () is the elasticity of q ( ). This inequality is likely to be satised when the two inputs are highly substitutable, that is, when is close to 1, when wage differences are large, when () is close to 1, or when unemployment is low to start with. Thus, only increases in unemployment benets that start from moderate levels increase the number of good jobs. The impact on welfare depends on how large the effect on is relative to the effect on . We can see this by totally differentiating equation (18) after substituting for u. This gives a relationship between and , drawn as the dashed line in gure 1, along which total surplus is constant. Shifts
9 It is straightforward to extend the analysis to show that in the case where there are multiple equilibria, labor market regulations make the equilibrium with more good jobs more likely. 10 To see this formally, totally differentiate eqq. (13) and (14) with respect to , , and z, and write A ( d d ) bdz, where A is a 2 2 matrix and b (1 1) . It is straightforward to see that in a stable equilibrium determinant A 0 and a 11 a 21 q ( )( r s )( rk g rk b )/ q ( ) 2 0, which gives d / dz 0.

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15

of this curve toward the northeast give a higher surplus. When this curve is steeper than locus (14), a higher z can improve welfare, and this is the case drawn in gure 1. For example, if is very low to start with, then unemployment will be too low relative to the social optimum (see Hosios 1990a; Pissarides 1990); in this case, an increase in z will unambiguously increase total welfare.11 More generally, regardless of whether total surplus increases, a more generous unemployment benet raises average labor productivity, p b (1 ) p g , which is unambiguously decreasing in . Therefore, when unemployment benets increase, the composition of jobs shifts toward more capital-intensive good jobs and labor productivity increases. A minimum wage has a similar effect on job composition. Consider a minimum wage w such that w b w w g , so the wage is only binding F F for bad jobs. The equation for J b now becomes J b ( pb w sk b )/( r s ). Then, equation (13) changes to q pb w rk b. r s q (20)

Since at a given , the left-hand side of equation (20) is less than that of equation (13), the impact of a higher minimum wage is to shift the bad-job locus, curve (13) in gure 1, down. The good-job locus is still given by equation (14), but now, combining equations (4) and (5), we have rJ U G , r s z q w 1 p g rk g . r s q 1 1 1

Since w w b , both curves shift down in gure 1, but, as in the case of unemployment benets, curve (13) shifts down by more, so both and fall. Again, the rise in minimum wages can increase the number, not just the proportion, of good jobs and total welfare. Moreover, for the same decline in , an increase in minimum wages reduces more than does an increase in z; therefore, minimum wages appear to be more powerful in shifting the composition of employment away from bad jobs toward good jobs. Overall: PROPOSITION 3. Both the introduction of a minimum wage w and an increase in unemployment benet z decrease and . Therefore, they

11 Namely, dTS / dz [( TS / ) /( d )/ dz )] [( TS / () d / dz )]. The rst term is positive, and if is sufciently low that TS / 0, then the second term will be positive too, and an increase in z will unambiguously increase net output.

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improve the composition of jobs and average labor productivity, but they increase unemployment. The impact on overall surplus is ambiguous. This section only reported the response of the steady state to changes in policy. Transitory dynamics are more involved but do not change the basic predictions. Essentially, in response to an increase in z (or a binding minimum wage, w ), the economy stops creating bad jobs for a while and creates only good jobs. Therefore, the short-run impact of the policy changes will be quite large. Overall, in nite time, the right fraction of good jobs and bad jobs is achieved, but the unemployment rate adjusts more slowly. As a full analysis of transitory dynamics requires considerably more notation, the details are left out. III. Extensions A. Endogenous Search Effort In the above analysis, although higher unemployment benets and minimum wages improve the composition of jobs and potentially welfare, they always increase unemployment. However, this not a general result. If we also include a margin of choice on the worker side, this result no longer holds. In this subsection, I briey outline the simplest way of modelling this by introducing search effort (see, e.g., Pissarides 1990). I assume that the matching function is given as M ( e u , v ), where e is the average search effort of unemployed workers. Similar equations can now v/e be written, but needs to be dened as u. Throughout this section, I will only consider symmetric steady-state equilibria in which all workers use the same strategy; thus e e . The probability that a worker q( ), where v/e searching at intensity e nds a job is e u. I also assume that the ow cost of choosing search effort e is c( e ), where c is a strictly increasing, differentiable, and convex function. Then, the Bellman equations for the rm are unchanged and, for the worker, only equation (4) changes. It is replaced by
E E q J b rJ U z c e e 1 J g J U .

(21)

Also, equation (10) now becomes u s q . se

Differentiating equation (21), we get the condition for e to be chosen optimally, and evaluating this in equilibrium, that is, where e e , we obtain
E E q J b 1 J g J U c e .

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, As before, for given e , an increase in the minimum wage will reduce but with endogenous search effort, it will also increase e (as long as it E increases J b ). Therefore, the overall impact on u is ambiguous: if the change in e is large enough, unemployment may fall because the increase in wages caused by the minimum wage legislation encourages all workers to search more. This model with variable search effort therefore offers an alternative and complementary explanation to Burdett and Mortensens (1989) model for why, in the instances studied by Card and Krueger (1995), higher minimum wages did not reduce employment of affected workers and may have even increased it slightly. The analysis of an increase in unemployment benet is similar. However, the impact of unemployment benets on employment is now more negative. This is because, in contrast to an increase in minimum wage, which tends to encourage search, a higher level of z creates a standard moral hazard effect and discourages search effort. B. Directed Search In practice, workers do have some information about which sectors pay higher wages. Therefore, a model of directed search where workers decide for which type of job to apply describes the functioning of the labor market better. This subsection briey discusses the extension of the model to include directed search. Suppose that workers can apply to the good-job sector or to the bad-job sector. The number of bad-job matches is given by M ( u b , v b ) and that for good jobs is given by M ( u g , v g ), where u i is the number of unemployed workers applying to i -type jobs and v i is the number of i -type vacancies.12 The assumption that both sectors have exactly the same matching function is for simplicity and highlights that differences in the technology of matching are not the source of the results. Since M ( , ) exhibits constant returns to scale, the ow rate of a match for a worker applying to sector i is i q ( i ), and the ow rate of a match for a type i -vacancy is q ( i ). The steady-state value of an unemployed worker applying to sector i is
E U rJ U i z iq i J i J i .

(22)

U For there to be both types of jobs, we require that rJ U rJ b rJ U g . The other Bellman equations, (5), (6), and (7); the wage equation (8); and the zero-prot condition (9) are the same as above. Now, we have to determine b and g separately, and the aggregate production of bad and good

12 See Acemoglu and Shimer (1999b, 2000) for a detailed analysis of directed search with wage posting.

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intermediate goods are Y b (1 u b ) and Y g (1 u g )(1 ), where is the fraction of workers applying to the bad-job sector. The price equation (11) is also modied accordingly. An equilibrium exists and, since equation (12) still applies, we have w g U w b . Worker indifference between the two sectors, rJ b rJ U g , also implies that b q ( b ) g q ( g ), that is, that workers who apply to bad jobs suffer shorter unemployment spells. This is in line with the evidence cited in the introduction that high-wage jobs attract longer queues (Holzer, Katz, and Krueger 1995). Labor market regulations have the same effects as before in this model. First, a higher level of z at given b , g , u b , U and u g would lead to rJ U g rJ b , which would encourage more workers to apply to the good-job sector. To ensure the indifference condition for U workers, rJ b rJ U g , p g and w g have to decline, so the production of good g and the fraction of workers applying to the good-job sector, 1 , will increase and the price of the output of sector g will fall. Therefore, the unemployment benet once again shifts the composition of employment toward high-wage jobs. Minimum wages will again work more directly by pushing w b up, thus reducing prots from opening bad jobs and encouraging the creation of more good jobs. Welfare implications are now more complicated, and they depend on whether the bargaining power of workers, , is greater than or less than the elasticity of the matching function, () (Hosios 1990a). When (), there will be too little job creation, and the composition of jobs will be biased toward low-wage jobs. The reason why directed search does not necessarily help in solving the inefciency problem is that rms are unable to commit to wages, which are still determined by bargaining after matching takes place.13 C. Unemployment Benets Conditional on Past History The analysis so far has considered an unemployment insurance system that pays a constant amount z to all unemployed workers. In practice, the level of benets depends on the earnings history of individual workers, often with a progressive form. This can be incorporated into the model by introducing two levels of unemployment benets, z g and z b , such that workers previously employed in a good (high-wage) job receive z g , while those previously employed in a bad (low-wage) job receive z b . The analysis becomes considerably more complicated, in part because the value of obtaining a certain job includes future unemployment benets that the worker will receive after being employed at this job. The main

13 See Acemoglu and Shimer (1999b) for a discussion of the differences between directed search and wage posting. The results in Acemoglu and Shimer (1999b) also imply that when (), the composition of jobs would be efcient.

Good Jobs versus Bad Jobs

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results are unaffected, but we obtain the additional result that an increase in the progressivity of unemployment benets increases the fraction of low-wage jobs. Notice that in this setup, workers have a further reason to wait for high-wage jobs, since these are associated with a higher unemployment benet, z g , in the future. An increase in the progressivity of the unemployment benet system, which corresponds to a decrease in z g relative to z b , therefore weakens this motive and makes workers more willing to take low-wage jobs. This encourages the creation of more bad jobs. D. Capital-Labor Substitution The technology of production used so far is Leontieff, and each rm employs only one worker. So there is no room for capital-labor substitution within rms. It is instructive to investigate whether the results generalize to the case with capital-labor substitution and diminishing returns to labor. With diminishing returns, the exact form of bargaining becomes important. If workers bargain as a group against the rm, for example in the form of a union, the results so far immediately generalize. The more involved case is the one where the rm bargains individually with each worker. This case has been analyzed by Stole and Zwiebel (1996), who use a bargaining concept similar to the Shapley value. A striking result of their analysis is that, when a rm bargaining with each employee individually faces a perfectly elastic demand curve, it will hire more workers than would a wage-taking rm. It will do so to reduce the productivity contribution of a marginal worker and to hold down workers to their outside option. In our context, suppose that a rm in the g sector has the production function k 1 l g and a rm in the b sector has g 1 the production function k b l b , where , ensuring that the b sector is more labor-intensive. It is straightforward that a wage-taking rm facing ) 1/(1 ) a wage of v would choose l g 1/(1 ) p 1/(1 v k g . Stole and g Zwiebels (1996) result 1 implies that a rm bargaining with its employees (2 ) 1/(1 ) (1 ) 1/(1 ) individually will instead hire l g 1/(1 ) 1/(1 ) pg v k g l g , and it will pay v to all of its employees. Similar expressions apply for sector b rms; they, too, pay v to all their employees; so wage differentials across workers disappear. This may suggest that the results here do not generalize to a situation with capital-labor substitution, diminishing returns to labor, and individual bargaining between rms and workers. This is not necessarily the case, however. The main difference between the situation considered by Stole and Zwiebel (1996) and my model is that here the rm cannot costlessly hire new workers. Instead, after a rm purchases the required equipment and opens a vacancy, recruitment of workers will be a slow process, which is the source of all the inefciencies and of the results in the above analysis. Therefore, even if the rm nds it optimal to build up its labor

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, there will be an extended period of time during which the force to l g productivity of the marginal worker is quite high, and during this period, the rm will have to pay high wages. Although such a model is quite difcult to solve, it seems natural that this problem would imply higher labor costs for sector g rms than for sector b rms, which would once again bias the composition of jobs toward low wages.14 References Acemoglu, Daron. A Microfoundation for Increasing Returns in Human Capital Accumulation. Quarterly Journal of Economics 111 (August 1996): 779 804. . Training and Innovation in an Imperfect Labor Market. Review of Economic Studies 64 (July 1997): 445 64. . Changes in Unemployment and Wage Inequality: An Alternative Theory and Some Evidence. American Economic Review 89 (December 1999): 1259 78. Acemoglu, Daron, and Shimer, Robert. Efcient Unemployment Insurance. Journal of Political Economy. 107 (October 1999): 893928. (a) . Holdups and Efciency in Search Equilibrium. International Economic Review (November 1999). (b) . Wage and Technology Dispersion Review of Economic Studies (2000), in press. Atkinson, Anthony, and Micklewright, John. Unemployment Compensation and Labor Market Transitions: A Critical Review. Journal of Economic Literature 29 (December 1991): 1679 1727. Bulow, Jeremy, and Summers, Lawrence. A Theory of Dual Labor Markets with Applications to Industrial Policy, Discrimination and Keynesian Unemployment. Journal of Labor Economics 4 (July 1986): 376 414. Burdett, Kenneth, and Mortensen, Dale. Equilibrium Wage Differentials and Employer Size Effects. Photocopied. Evanston, IL: Northwestern University, 1989. Card, David, and Krueger, Alan. Measurement and Myth: The New Economics of the Minimum Wage. Princeton, NJ: Princeton University Press, 1995. Davidson, Carl; Martin, Lawrence; and Matusz, Steven. Search, Unemployment, and the Production of Jobs. Economic Journal 97 (December 1987): 85776. . The Structure of Simple General Equilibrium Models with Frictional Unemployment. Journal of Political Economy 96, no. 6 (December 1988): 126793.

14 /l l / l , so the more capital-intensive g Also, it can be veried that l g g b b sector has to overemploy more than the b sector. This implies that the costs of preventing interrm bargaining is higher for sector g rms, again inefciently biasing employment and production toward the b sector.

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Davis, Steve. The Quality Distribution of Jobs in Search Equilibrium. Photocopied. Chicago: University of Chicago, 1995. Diamond, Peter. Mobility Costs, Frictional Unemployment and Efciency. Journal of Political Economy 89 (August 1981): 798 812. . Wage Determination and Efciency in Search Equilibrium. Review of Economics Studies 49, no. 2 (April 1982): 21727. Dickens, William, and Katz, Lawrence. Interindustry Wage Differences and Theories of Wage Determination. Working Paper no. 2271. Cambridge, MA: National Bureau of Economic Research, 1987. Ehrenberg, Ronald, and Oaxaca, Ronald. Unemployment Insurance, Duration of Unemployment and Subsequent Wage Gain. American Economic Review 66 (December 1976): 754 66. Gibbons, Robert, and Katz, Lawrence. Does Unmeasured Ability Explain Inter-Industry Wage Differentials. Review of Economic Studies 59 (July 1992): 51535. Grout, Paul. Investment and Wages in the Absence of Binding Contracts: A Nash Bargaining Approach. Econometrica 52 (March 1984): 449 60. Harrison, Bennett, and Bluestone, Barry. The Great U-Turn. New York: Basic, 1988. Holzer, Harry; Katz, Lawrence; and Krueger, Alan. Job Queues and Wages. Quarterly Journal of Economics 106 (August 1991): 739 68. Hosios, Arthur. On the Efciency of Matching and Related Models of Search and Unemployment. Review of Economics Studies 57, no. 2 (April 1990): 279 98. (a) . Factor Market Search and the Structure of Simple General Equilibrium Models. Journal of Political Economy 98 (April 1990): 32555. (b) Krueger, Alan, and Summers, Lawrence. Reections on the Inter-Industry Wage Differentials. In Unemployment and the Structure of Labor Markets, edited by Kevin Lang and Jonathan Leonard, pp. 17 45. New York: Basil Blackwell, 1987. . Efciency Wages and the Inter-Industry Wage Structure. Econometrica 56 (March 1988): 259 93. Lang, Kevin. Pareto Improving Minimum Wage Laws. Economic Inquiry 25 (January 1987): 14558. Marimon, Ramon, and Zilibotti, Fabrizio. Unemployment versus Mismatch of Talent. Economic Journal (April 1999): 266 91. Mortensen, Dale. Unemployment Insurance and Job Search Decisions. Industrial and Labor Relations Review 30 (July 1977): 50517. . Property Rights and Efciency in Mating, Racing and Related Games. American Economic Review 72 (December 1982): 968 79. Pissarides, Christopher. Equilibrium Unemployment Theory. Cambridge, MA: Basil Blackwell, 1990. . Search Unemployment with on the Job Search. Review of Economic Studies 61 (July 1994): 45776. Stole, Lars A., and Zwiebel, Jeffrey. Organizational Design and Technology Choice under Intrarm Bargaining. American Economic Review 85 (March 1996): 195222.