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Can Labour Market Rigidity Lead to Economic Efficiency?

Gianluca Grimalda

CSGR Working Paper Series 186/05

December 2005

The extent to which labour market rigidity can be beneficial for an economy is investigated in a model where technological change is non-general purpose and different types of skills are available to workers. More precisely, specific skills lock a worker into a particular technology but increases productivity. Conversely, general skills allow workers to move across technologies at the cost of lesser productivity. Labour market rigidity is modelled as cross-sectors transfer costs for general skill workers. The main result is that a positive level of labour market rigidity is in general beneficial for the economy. In fact, ex post efficiency calls for low market rigidity, as this allows more workers to transfer to the innovating sector of the economy. Conversely, ex ante efficiency calls for high labour market rigidity, as this favours workers’ acquisition of specific skills, which increases output. The combination of these two effects results in an inverse-U shaped relationship between output and labour market rigidity. A necessary condition for this result to hold is that the acquisition of specific skills is ex ante costly, as the rent that must be paid in equilibrium to specific skill workers determines a gap in marginal productivity in favour of specific skill labour.

Keywords:Non-general purpose technology, labour market rigidity, specific and general human capital.

JEL classification: J24, J31, O30