Lazear (1981) sets out a model which, in the absence of any on-the-job training,
generates an upward sloping age earnings profile to encourage worker effort and reduce
shirking.(19) The firm offers a contract for long term employment combined with an
upward sloping earnings profile (see figure 2.5). Workers have the option of accepting
the alternative wage (WQ) equal to their marginal product or opting for a wage (Wt) which is initially below their marginal product and eventually rises above their marginal
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Figure 2.5: Lazear's Shirking Model.
Experience
product until their retirement at R. In equilibrium, the discounted value of these two
income streams will be equated for the marginal worker and there would be no queuing
for the job. However, in order to remain on the earnings path W j , it is necessary that
the employee continue to work hard. Once experience is greater than (f), dismissal
involves a substantial loss of income. For example, an individual dismissed with
experience level (a) in figure 2.5 would lose earnings represented by the area (bcde). The
steeper the earnings profile the greater the incentive for the worker to work hard to keep
his job. A steeper profile however, also gives the firm a greater incentive to cheat and to
attempt to terminate contracts at (f). As long as new workers have information on the
past history of the firm's hiring and firing practices, there is a cost to the firm of cheating
which should encourage the firm to fulfill its part of the contract.
Lazear (1981) noted that the predictions from this model were difficult to
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upward sloping age earnings profile consistent with each theory, may be observed, it is
not possible to observe its relationship to the marginal product curve. Even a difference
between marginal product and earnings would be insufficient evidence to support the
shirking model against the human capital model. Human capital predicts that in the case
of specific training, there will be a divergence between marginal product and earnings,
with marginal product exceeding earnings in the post investment period. It is difficult to
see how we could test between these two models without detailed knowledge of
monitoring costs and firm specific investment.
An additional difficulty of the model comes from its justification of a rising age
earnings profile on the basis of the monitoring costs of shirking alone. Although it may
not be possible to monitor an individual’s output on a daily basis, surely over a year the
firm will have some idea of the employee's productivity. It is then difficult to justify the
postponement of the bonus for not shirking to the end of their working life rather than
the firm adopting the alternative of the payment of an annual bonus.
Lazeaf s shirking model suggests that the differences in the aggregate age earnings
profiles of the three countries might be explained in terms of industry mix. It might be
suggested that the industry mix is such that the potential for shirking created by such
factors as the choice of technology and the size of firms is greater in the US than in
Australia and produces a steeper earnings profile. We would expect on the basis of this
model, that the returns to experience with one employer were higher in the US than in
Australia and that workers tended to stay longer with a given employer in the US. We
will, however, be unable to test these predictions given our data sets and in principle,
they are difficult to distinguish from the predictions of the human capital model. So, for
example, the prediction on job tenure would not help us to distinguish between shirking
and the human capital model as this prediction also comes out of a specific human capital
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3.2 T h e L a b o u r T u rn o v e r M odel.
The model presented by Salop and Salop (1976) offers an alternative rationale for
an upward sloping earnings profile unrelated to higher levels of productivity among
older workers. In this model, turnover is costly to the firm as it generates training,
processing and other related costs. As there is inadequate information about potential
workers and their propensity to quit, the firm has an incentive to adopt an earnings
structure which encourages workers to "self select" into jobs for "quitters" and
"stayers".
In the absence of self selection, all workers have the option of a wage equal to their
marginal product less the turnover costs (initial training costs and processing costs)
W* = M(IVN) - (R+Q)T (11)
where W* is the market clearing wage.
Q = the average quit rate for all firms.
L = no. of workers who supply their services to the market inelastically.
n = the number of identical perfectly competitive firms with marginal revenue product
functions M(L).
R = discount rate.
T = costs incurred per new employee.
The firm can alternatively offer a Two Part Wage (TPW) where the new employee pays
an entrance fee of D1 and receives a wage (W*+D2). If a worker with a quit probability
Q can borrow at rate R, he will prefer the steeper profile if the following expression, his
net gain E(q), is positive and be indifferent between the TPW and the flat earnings
profile if it equals zero.
E(q) = - D1 + D2(1/(R+Q)) (12)
The firm can then choose D1 and D2 so that slow quitters prefer the steep structure
For this model to differ from a model where the firm invests in specific human
capital, the costs of turnover must be in addition to any costs the firm incurs through
investment in human capital. Otherwise we can just think of this model as another
example of a human capital model.
Salop and Salop's model suggests two alternative explanations of the differences
in the age earnings profiles of the three countries shown in Figure 1.1 chapter 1. Firstly, it is possible that turnover costs are lower either in general or in the mix of industries
found in Australia compared with the US. This may arise, for example, because of
differences in the costs of recruitment (advertising, travel costs and interviews).
Alternatively, Australia may be peopled by fast quitters unwilling to make the initial
sacrifices in order to get on the rising age earnings profile. Once again we would expect
to observe differences in job tenure between the countries with higher job tenure in the
US than in Australia.
3.3 Summary of These Models.
We are interested here in drawing together the predictions of these models which
relate to our three country comparison. Whatever the rationale for an upward sloping
earnings profile, that is to reduce shirking or turnover, these models predict less job
turnover where there is a steeper profile. We would therefore expect lower labour
turnover in the US than in Australia. We cannot test this given our data sets but other
evidence suggests that turnover may be higher in Australia than in the US.(20)
Another prediction relates to the effect of industry mix on the aggregate age
earnings profile. If these hypotheses were to explain the differences between Australia,
Great Britain and the US in the shape of the age earnings profiles, it would be necessary
to show that the potential for shirking created by such factors as the choice of technology
and the size o f firms is higher in the US or that the cost of labour turnover is higher in
the mix of industries in the US than in Australia. Either of these explanations would
difficult to distinguish these hypothesis from the standard human capital model on the
basis of predictions. Human capital theory also predicts low labour turnover and an
effect of industry mix on the aggregate earnings profile in the presence of industry-
specific training.