Strategic Innovation with Complete and Incomplete Labour Market Contracts

In a model of strategic R&D competition between two firms that negotiate with independent unions we show that: (i) incomplete labour market contracts may Pareto-dominate complete labour market contracts (ii) even when complete contracts Pareto-dominate incomplete contracts, economies can get stuck in the incomplete contract equilibrium. These conclusions provide additional strategic reasons why complete labour market contracts may not be used—even if they were feasible. We propose two testable predictions to discriminate between complete and incomplete contracts: (i) the variance of wages is lower with complete contracts; (ii) the variance of employment is higher under complete contracts.