Equilibrium Unemployment as a Worker Discipline Device

Involuntary unemployment appears to be a persistent feature of many modern labor markets. The presence of such unemployment raises the question of why wages do not fall to clear labor markets. In this paper we show how the information structure of employer-employee relationships, in particular the inability of employers to costlessly observe workers' on-the-job effort, can explain involuntary unemployment as an equilibrium phenomenon. Indeed, we show that imperfect monitoring necessitates unemployment in equilibrium.