The Economics of Internal Labor Markets

Abstract

Our essay focuses on the economics of long‐term contractual relationships between a firm and its employees, referred to as the internal labor market. We review the economics literature on match‐specific investments, risk aversion, asymmetric information, and transaction costs. We argue that an integrated treatment of all four factors is needed in order to apply implicit contract theoy to internal labor markets. Integrating the topics also highlights the tradeoffs created among these factors. Our discussion stresses contract enforcement mechanisms, including self‐enforcing contracts and third‐party enforcement.

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