Matt Elliott

In many markets parties must make relationship specific investments before they can trade with each other. These investments are subject to agency problems. A hold-up problem can result in under-investment and there can also be over-investment to generate ‘outside options’ - A relationship with one party may be invested in to affect the terms of trade with another. If both parties must make fixed non-substitutable investments the hold-up problem is most severe and under-investment inefficiency can consume all the gains from trade. In contrast over-investment inefficiency is bounded. Fixed, non-substitutable investments are a reasonable approximation of some markets, but not others. When countries invest in a pipeline to trade natural gas they negotiate their shares of the pipeline costs. Negotiated investments have not previously been considered. Allowing for them dramatically changes the results. Under-investment inefficiency is eliminated, but over-investment inefficiency can now consume all the gains from trade.

This paper builds a framework in which to place search models of unemployment. It is able to nest much of literature which is united by representing different restrictions on which people can be employed by which firms as a network. Search and then bargaining is modeled over the network and the efficiency of labor market entry decisions revisited. It is shown that in a general dynamic model no one level of bargaining power can achieve efficient vacancy creation, even if people’s entry decisions are trivial. Further, when people’s entry decisions are not trivial but there is some uncertainty no one level of bargaining power can achieve efficient entry even in a one period model. Nonetheless, a policy that sets workers’ search costs to zero and transfers all the bargaining power to firms is able to achieve efficiency as a sequential equilibrium of the dynamic entry game when the information available to firms is restricted. The framework is then used to explain why search technology improvements may not be translated into a reduction in equilibrium unemployment.