Negishi–Solow efficiency wages, unemployment insurance and dynamic deterministic indeterminacy

Abstract

This paper introduces efficiency wages designed to provide workers with incentives to make appropriate effort levels, and involuntary unemployment, along the pioneering lines of Negishi (1979), Solow (1979) and Shapiro and Stiglitz (1984), in a dynamic model involving heterogeneous agents and financial constraints as in Woodford (1986) and Grandmont et al. (1998). Effort varies continuously while there is unemployment insurance funded out of taxation of labor incomes. Increasing unemployment insurance is beneficial to employment along the deterministic stationary state, and can even in some cases lead to a Pareto welfare improvement for all agents, through general equilibrium effects, by generating higher individual real labour incomes, hence larger consumptions of employed and unemployed workers, and thus higher production. In contrast, the local (in)determinacy properties of the stationary state are opposite to those obtained in the competitive specification of the model: local determinacy (indeterminacy) occurs for elasticities of capital‐efficient labor substitution lower (larger) than a quite small bound. Increasing unemployment insurance is more likely to lead to local indeterminacy and, therefore, to generate dynamic inefficiencies due to the corresponding expectations coordination failures.