Working hours reduction and wage contracting style in a dynamic model with labor adjustment costs

This paper formulates a dynamic framework that highlights the roles of wage contracting style and labor adjustment costs in order to inquire into the short-run transitional dynamics and the long-run steady effects of work-sharing arrangements. We show that the hourly wage system tends to increase the degree of wage flexibility, and therefore hours reductions may be an effective policy in terms of increasing the employment stock. However, within a salary-style wage regime workers' salaries are fixed by contract, and therefore a policy of reducing working hours will lead firms to hire fewer new workers, thus giving rise to less employment accumulation. Moreover, our analysis of the transition reveals that if the labor adjustment cost is low in response to a pre-announced reduction in working hours, the number of newly hired workers will overshoot its long-run level and will move in the opposite direction during the periods before and after the policy is actually implemented. (C) 2006 Elsevier B.V. All rights reserved.