May 2004

IZA DP No. 1133: Preferences for Rigid versus Individualized Wage Setting in Search Economies with Frictions

revised version published as 'Preferences for Collective Versus Individualised Wage Setting' in: Economic Journal, 2008, 119 (540), 1440-1463

Firing frictions and renegotiation costs affect worker and firm preferences for rigid wages versus individualized Nash bargaining in a standard model of equilibrium unemployment, in which workers vary by observable skill. Rigid wages permit savings on renegotiation costs and prevent workers from exploiting the firing friction. For standard calibrations, the model can account for political support for wage rigidity by both workers and firms, especially in labor markets for intermediate skills. The firing friction is necessary for this effect, and reinforces the impact of both turbulence and other labor market institutions on preferences for rigid wages.