The theory of contracts and labor practices in Japan and the United States

Labor management practices in Japan are quite different from those in the United States. We begin with the assumption that markets are incomplete, and use recent developments in contract theory to develop a conceptual framework to understand why the differences have been maintained. Our basic message will be that the American and Japanese systems are examples of two different equilibria. The distinguishing feature of these two equilibria will be the extent to which exit is used as a method of contract enforcement. In the United States there is a greater tendency for the use of exit because active markets exist for senior workers. In contrast, there is virtually no market for mid‐career workers in Japan. We also discuss the implications of this fundamental difference for the structure of the internal and external labor markets.