Up to the 1970s conventional Keynesian macroeconomic
analysis was mainly interpretated in the Hicksian IS/LM framework, without any attempt to construct the theory within an explicit disequilibrium context (Mankiw (1990)). In the seminal paper by Barro and Grossman (1971), which
built on the foundations laid down by Clower (1965) and Patinkin (1965), the Keynesian paradigm is interpretated in a general disequilibrium context where unemployment can arise either as a result of excessive wages and/or insufficient demand. The Barro-Grossman paper has initiated a growing bulk of New Keynesian theories of unemployment with the ambition of establishing microeconomic foundations to Keynesian macroeconomics. The mainstream New Keynesian theories of unemployment try to answer the following question; why are wages sticky when unemployment exists? The most popular New Keynesian theories of unemployment are the following.
Implicit contract theories. The early contributions by Azariadis (1975), Baily (1974) and D. F. Gordon (1974),
share two common assumptions. First, workers are more risk averse than employers due to occupational selection and less opportunities of the workers to diversify their human capital; and second, the contractual arrangement between workers and employers is implicit and unwritten. Since workers are assumed to be more risk averse than employers, it becomes optimal for firms to minimize the income variability of their workers. The outcome is sticky money wages. Sticky money wages may translates into real wage rigidities which prevent the labour market from clearing. An adverse demand shock therefore results in worker lay offs and unemployment.
Implicit contract theories have been questioned on two grounds. First, why do reductions in demand result in lay
offs rather than reduced hours (Gordon (1976)) . Second,
implicit contract theory is a theory of wage stickiness and not of employment (Stiglitz (1986)). Implicit contracts do
not result in unemployment fluctuations, and insurance
contracts in fact improve the functioning of a competitive
market. Stiglitz (1986) has demonstrated that implicit
contracts imply either full employment or overemployment and therefore it is difficult to justify them as theories of unemployment.
Efficiency wages. These theories hypothesize that worker
productivity is a positive function of the wage paid (Shapiro and Stiglitz (1984); Weiss (1980); Phelps (1970);
Salop (1979); Akerlof (1984)) . Unemployment is an
equilibrium response to information asymmetries and is triggered by wages in excess of market clearing levels. Keeping wages above the market clearing level is, from the firms' point of view, optimal as it encourage workers ncr to shirk, lowers labour turnover, attracts a high quaiiry labour force and increases the workers morale.
Yellen (1984) has questioned efficiency wage models on the following grounds: Why do other types of labour contracts, which are Pareto-superior to unemployment, not arise in efficiency wage models? Why do workers, in the training costs-reduction of labour turnover model, not pay the firm
for training or post a bond for leaving prematurely? Why do firms, in the shirking model, not impose a penalty payable to the firm for shirking? Workers should be willing to purchase jobs if they provide rents. This act would allow wages to adjust to eliminate the disequilibrium wage.
The efficiency-wage theories have had some empirical success. The efficiency-wage premium may vary across firms due to different monitoring and turnover costs. Studies by Dickens and Katz (1987), Krueger and Summers (1988) and Murphy and Topel (1987) observe that wage differentials are positively related to monopoly power, profitability, and capital intensity and these are likely to be positively related to monitoring and turnover costs.
Insider-outsider theories. Wages are set by insiders (employed) whose interests are represented by the unions and the unemployed (outsiders) have become disenfranchised
(Gregory (1982); Blanchard and Summers (1986, 1987); Lindbeck and Snower (1986b, 1987, 1988)). An unexpected negative shock raises unemployment, and the vicious circle which disenfranchises the unemployed is initiated. There are different mechanisms that cause a negative shock to have long-term unemployment effects: First, unemployed workers lose the opportunity to maintain and update their skills by working and over time they lose contact with the labour market (Blanchard and Summers (1986)). Second, the insiders have bargaining power over outsiders due to
turnover costs, hiring costs, training costs and firing costs, all of which make inside labour effectively cheaper then the outsiders (Lindbeck and Snower (1986)) . On behalf of the insiders the unions role is to amplify the costs of hiring, training and firing and thereby ensure the labour market advantages of their members. The implication of the insider-outsider story is that once unemployment increases in response to a negative shock an even stronger positive shock is needed to reverse the process due to the human capital deterioration among the long-term unemployed.
The insider-outsider theories (and the labour turnover efficiency wage model) predict that firms with the highest turnover costs will have the least flexible wages. Using sectoral data for Canada and France, Campbell (1989) finds evidence for this. Moreover, in concurrence with efficiency-wage theories, the insider-outsider theory is consistent with the fact that the most profitable ani capital intensive firms pay the highest wage premiums ana have the lowest quit rates. Finally, Gregory (1986) finds wage growth to be influenced significantly by labour utilisation within the firm, measured as overtime hours worked, but not by the unemployment rate for Australia after 1977. This suggests that insiders possess a stronger power in the wage negotiation process than outsiders.
3.3 Can the Above Theories Explain the Macroeconomic