Abstract
OECD countries have witnessed drastic reductions in labor share and a decoupling of skilled and unskilled wages. I design a model where labor relationships suffer from moral hazard. This friction produces a rent versus efficiency trade-off for workers and a multitasking problem for managers. Specifying functional forms and parameters of the model economy, I perform a dynamic numerical exercise. The main assumption is that productivity gains increase output per effort for workers and lowers costs and marginal costs of monitoring. I find that with an appropriate evolution of the productivity gain, owners fare better than managers who themselves fare better than workers thereby reproducing the aforementioned observation from their counterparts in the real economy.
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Notes
- 1.
See Howell et al. (2013).
- 2.
Intuitively, income inequality could affect economic growth through a number of different mechanisms; for instance, a deterioration of human capital and a lack of skills development of disadvantaged individuals.
- 3.
For a similar interpretation, see Radner (1992) who defines “managers” as all employees that “are classified as exempt from the provisions of the Fair Labor Standards Act” (page 1387).
- 4.
An alternative would have been to assume risk-averse agents. This would require the firm to pay a risk-premium again raising costs and marginal costs of inducing worker’s effort (see e.g. Holmström 1979). Assuming both risk averse and financially constrained agents also leads to similar results (see Demougin 2016 for a simple analysis of this case).
- 5.
See Demougin and Fluet (2001).
- 6.
For instance, Hubbard published two papers where he analyzes the impact of the installation of on board computers on the structure and productivity in the trucking industry (see Hubbard 2000 and Hubbard 2003). Similarly, Miozzo and Ramirez (2003) analyzes the effect of the new information technology to monitor tasks of field engineers in the UK telecommunication industry.
- 7.
The restriction on the slope of v(⋅ ) at e = 1 guarantees an interior solution.
- 8.
Risk-neutrality guarantees that aggregating the informational content of a signal with n > 2 realizations into a binary signal entails no loss of generality. For a complete analysis of this claim, see Demougin and Fluet (1998) where the distinction between a sufficient statistic in the usual sense and that of a mechanism sufficient statistic is analyzed.
- 9.
In absence of the domain restriction on e, one could have introduced an additional increasing concave function p(e) with range over the unit interval and then defined \(\Pr \left [s = 1\ \vert \ e,\theta \right ] = p(e)^{\theta }\). Demougin and Fluet (2001) provide a natural example which would lead to such a specification. That paper also analyzes the resulting trade-off between the workers’ rent and the monitoring costs.
- 10.
This assumption is important because otherwise, as is well known from the literature, the firm could use a bonding contract to extract the all the agent’s rent in which case the first-best solution would maximize profit.
- 11.
For parsimony of analysis, I do not model the firm’s decision of capital. In the current setup k can be interpreted as the per worker capital costs in an environment where the capital/labor ratio is held constant throughout the analysis.
- 12.
Multitasking problem obtains when using a proxy variable leads to a misalignment of incentives across different activities. For a simple and didactic example, see the paper by Baker (2002).
- 13.
An alternative would have been to introduce an additional supervisory/monitoring scheme for managerial activities. Based on the outcome of monitoring, the manager could be paid a bonus. In practice this type of contracts are seldomly observed whereas profit sharing schemes are very common.
- 14.
If θ was not known to the worker, but to be decided by the manager, it would yield to a double moral hazard problem. The solution of that problem may be quite different (see for instance Bental et al. 2012).
- 15.
More generally, suppose the contract pays w s when the realization of the proxy is s. Then the bonus scheme is simply F = w 0 and B = w 1 − w 0.
- 16.
Demougin and Helm (2006) use a principal agent environment similar to the manager agent relationship in the current paper and analyze the implication of more a evenly distributed bargaining power. The results from that publication, suggests that a different allocation of bargaining power would not fundamentally affect the findings of the current exercise.
- 17.
This is in line with OECD experience for the period 1980–2002 (see for instance, the discussion of Macroeconomic indicators in Bental and Demougin 2010).
- 18.
For instance, in 1980 the Labor Share of Germany was 69%, of France 74% and that of the US 67%.
- 19.
See Irwin (2014) on the controversy of Piketty vs. The Financial Times in the New York Times May 30, 2014.
- 20.
The quote is taken from the opening statement in Lucas (1980) JMCB paper on “Methods and Problems in Business Cycle Theory”.
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Demougin, D. (2017). Rising Income Inequality: An Incentive Contract Explanation. In: Heinemann, F., Klüh, U., Watzka, S. (eds) Monetary Policy, Financial Crises, and the Macroeconomy. Springer, Cham. https://doi.org/10.1007/978-3-319-56261-2_15
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