The starting point of the analysis is that a significant proportion of
the labour force is not covered by efficient labour contracts. In par
ticular, the non-existence of forward labour contracts limits the oppo
rtunity of efficient risk-sharing through private arrangements among y
oung labour-suppliers and capital-owners. In such a context, state-dep
endent labour taxes and employment subsidies would be required to achi
eve ex ante Pareto efficiency. In the absence of employment subsidies,
a certain (limited) degree of downward wage rigidity is in general Pa
reto superior to full wage flexibility. At the second-best optimum so
defined, productive efficiency is sacrificed in some states, in order
to achieve greater efficiency in risk-sharing. Thus, the unemployment
associated with wage rigidity is inefficient, though voluntary due to
the levels of benefits, and second-best efficient. A limited degree of
wage discrimination by hiring date is typically part of the second-be
st policy.