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2002 Documento de Trabajo #151

Profit Sharing Reconsidered: Efficiency Wages and Renegotiation Costs

Weitzman (1983, 1984, 1985, 1986 and 1987) strongly advocated policy measures tointroduce profit sharing. His recommendations consisted of tax deductions on incomes derived from a share on profits. The basis for these incentives is the association of profit sharing and two sorts of externalities. First, if the economy is characterised by short run wage rigidity, profit sharing reduces short run unemployment. Second, profit sharing might reduce long run unemployment.Until 1985, profit sharing was justified in terms of its short run properties, and both contractswere considered to have the same long run equilibrium. This long run isomorphism was broken when both contracts were compared under hypotheses attempting to explain involuntary unemployment in the long run.A first microeconomic foundation for long run wage rigidity is the insider-outsider hypothesis.In Weitzman`s (1987) insider-outsider analysis a sharing contract has a lower NAIRU than its wagecounterpart, due to the decrease in insiders` power, when, first, the employer retains the employment decision, and second, there is no absolute collusion. Problems of stability of a share contract at full employment are added now to justify tax incentives, as the median worker will always (individually)prefer a decrease in the share parameter, implying that the economy converges to the wage system. Trade union`s objectives change (Mitchell, 1987, Fung, 1988 and 1989, Pohjola, 1987, Jackman,1988, and Hoel and Moene, 1988): the consideration of firms’ profits in their own objective function lead to the superior Pareto properties of the share system1.*Centro de Economía Aplicada, Departamento de Ingeniería Industrial, Facultad de Ciencias Físicas y Matemáticas, Universidad de Chile. I would like to thank Anthony Atkinson, Alan Manning, Robert Rowthorn and the participants in a seminar at the Catholic University of Chile for helpful comments and suggestions. The usual disclaimers apply.1In some cases, the gains for workers and firms are, in part, obtained at the expense of consumers and the unemployed (Fung, 1989, Nuti, 1987, and Mitchell, 1987). Nuti (1987) and Mitchell (1987) analyze the likelyeffects of profit sharing on industrial relations. It seems that profit sharing tends to decrease the monopoly effect of trade unions while increasing the beneficial voice effect. It also tends to a larger level of trade union.

Pablo González