Missing Market in Labor Quality The Role of Quality Markets.pdf

Missing Market in Labor Quality: The Role of Quality Markets in Transition1 Gary H. Jefferson jefferson@brandeis.edu Graduate School of International Economics and Finance Brandeis University Presented at “The 4th Annual International Conference on Transition Economics” Beijing, China July 23-25, 1999 (revised February 1, 2001) Abstract This paper characterizes a key feature of the classic socialist economy and state-owned enterprise, namely that of missing markets in labor quality. Under the socialist regime in which students and workers are assigned to work units and the rights of managers to monitor and reward workers are limited, the exchange of labor services is characterized by the quantity of such services rather than by their quality. Wages are relatively compressed. The grant to workers of the right of job mobility, including the right to trade on skill and effort, and the emergence of firms in which managers enjoy the right and incentive to monitor labor quality create the essential elements of markets in labor quality. The establishment of asymmetric property rights, through the creation of managerial control rights in the emerging fringe but not in the established state sector, creates a problem of adverse selection. The exit of high quality workers from the state sector weakens average productivity; as relative revenue and wage growth lag, successive tiers of quality workers exit from the state-owned enterprise, causing its successive weakening and eventual demise – or reform. By extending the principles of the Coase Theorem to the creation of a