The Equilibrium Organization of Labor

We look for the equilibrium mix of trading institutions when manufacturers need sequences of labor services. The environment has two critical features: (a) Multilateral matching allows gains from specialization, but players incur specific set-up costs each time they are matched with a new trading partner. (b) Bilateral relationships economize on set-up costs, but are burdened by bargaining costs. Under weak conditions, four mechanisms weakly dominate all others: Markets, employment with negotiated wages, employment with market wages, and bilateral sequential contracting. In labor market equilibrium, markets are used for services that take longer time to perform, are in less demand, require fewer partner-specific investments, and have larger cost differences between sellers. The most efficient sellers work as specialist employees, those of medium efficiency sell their services as professionals in markets, and the least efficient become employees. Large firms hire specialists, medium-sized firms use employees or the market, and small firms use the market exclusively