Sources of market failures and rationales for public policy interventions
From the above one could conclude that ‘workers’ rights in jobs do exist as a result of voluntary exchanges’ (Addison, 1989, p. 136) and that, consequently, there is no need for legislation.
This has, indeed, been the view taken by the proponents of a radical laissez-faire in labour relations who have postulated that, given clearly defined and assigned property rights, unconstrained voluntary negotiations between private parties produce ‘optimal’ results and, therefore, have opposed any further interventions in the labour market (see, for instance, Epstein, 1984; Posner, 1984, pp. 990ff.). Such arguments rest on the assumption that freely negotiated, private contracts are also able to provide efficient solutions to the dual problem of opportunistic behaviour and future contingencies inherent in labour market transactions. Conversely, any plea for (or defence of) employment security legislation must provide evidence that mere private contracting in modern labour markets produces inefficiencies that can be avoided or minimized by third-party interventions.Indeed, a large and growing body of research on labour law regulation (see, for example, Leslie, 1989; Schwab, 1989) and regulation in other fields (see Shavell, 1984; Cooter and Ulen, 1988; Spulber, 1989) has pointed out various situations in which market failures are likely to occur and in which third-party regulation (legislation) may produce superior results. Such a situation arises whenever the negotiation and monitoring of private contracts would involve very high transaction costs that can be reduced by the establishment of general standards and rules by an external agency. With increasing sunk investments, increasing time horizons for reaping the rents thereof and an overall increasing volatility in the economic environment, the transaction costs of privately negotiating individual contracts between firms and workers can be expected to rise.
Another situation for efficiency gains through legislation arises when private parties (in our case, firms and workers) are likely to agree on terms that produce external costs for third parties not involved in the original bargain (‘externalities’), pointing to the fact that real markets are frequently not fully competitive. For the labour market, ‘insider-outsider’ theories provide many illustrations of how ‘efficient’ bargains between two parties (‘insiders’ and firms) produce costs for non-participating outsiders. In these cases, legal regulation forcing the parties to fully internalize the costs of their behaviour may be efficiency enhancing.Binding legal standards may further increase overall efficiency if the enforcement of private contracts is very costly and legislation could provide enforcement at a lower cost. This is the case whenever contractual compliance is difficult to monitor, contract terms are vague and may give rise to conflicting interpretations, damages resulting from non-compliance are difficult to measure and causation of damages or harms is difficult to establish. In such instances, conflicts over contract terms are more likely to arise and to entail costly information gathering by external arbitrators in the course of lengthy case-by-case fact-finding investigations in which the (frequently implicit) actual terms of the contract and the behaviours of both parties during the employment relationship have to be retrospectively established, thus producing a high degree of (legal) uncertainty for both sides (see Craswell and Calfee, 1986; Kolstad, 1990). In fact, the aforementioned describes exactly those problems which have prompted several critics of the US common law system to recommend the introduction of European-type ‘unjust dismissal’ legislation in the United States (see Krueger, 1991; Gould, 1993, pp. 63ff.; Maltby, 1994): given the growing complexity and contingencies involved in ‘modern’ employment relationships,7 the latter progressively cease to ‘fit comfortably into the traditional common law scheme’ (Leonard, 1988, p.
636).Finally, Levine (1991) has pointed out that private contracting may fail altogether to rule out the dual problem of adverse selection and moral hazard inherent in open-ended employment relationships involving sunk investments. As long as (for example) the negotiation of ‘just cause’ requirements for employment terminations is left exclusively to the discretion of private parties, firms offering ‘just cause’ are prone to attract workers who in other firms, following an ‘at-will’ policy would face a higher risk of being dismissed; for the individual firm, such adverse selection of job candidates and the ensuing higher risk of shirking once the workers are hired may have an incentive to discontinue offering ‘just cause’ standards for dismissals, thereby, of course, also affecting the lot of non-shirking workers. In such cases, legislation, by universalizing rules and standards for individual behaviour, may solve typical ‘prisoner’s dilemma’ situations and thereby contribute to increasing overall efficiency (see also Buttler and Walwei, 1994).
Summing up, there appear to be many instances in which third-party interventions, and dismissal legislation in particular, by mitigating the risk of market failure, may indeed foster efficient contracting between firms and workers and thus enhance, rather than impede, overall labour market efficiency. In the present context, this implies that the direct economic costs imposed by dismissal legislation, which have been the focus of the current debate on employment security policies, need to be carefully weighed against the alternative costs of merely private contracting and - if the latter should fail - the socioeconomic welfare costs of forgone sunk investments.