Workers in a long-term relationship often have an incentive to hide their ability early in the relationship to avoid having the firm increase the level of output expected from them in the future. We show that competition for older workers will permit the implementation of efficient piece-rate contracts. When the difficulty of the job is unobserved by the firm, Gibbons (1987) has shown that all piece-rate contracts will be inefficient. Together, these results may explain why piece rates are common in some jobs, such as agricultural work and sales, and not as popular for many manufacturing jobs.

This article presents an equilibrium model of a dual labor market. Firms are assumed to be identical ex ante, and dualism arises endogenously. The dual labor market outcome is supported by efficiency wage and search considerations. Firms choose wage/effort requirement packages optimally given optimal search and effort choice by workers, and vice versa. We prove existence and investigate the occurrence and nature of dual labor market equilibria.