The theory of compensating wage differentials predicts that there will be a
positive relationship between wages and poor working conditions and that
workers are fully compensated for poor working conditions through their wage.
In this article, we first present a theoretical model of compensating wage differentials
under the assumption of a perfectly competitive labor market to confirm
these predictions. We then show that empirical studies have found evidence
that contradicts these theoretical predictions. Specifically, we introduce
studies that show the following: (i) workers are not matched with their desired
working conditions, and those workers who report dissatisfaction with their
hours change employers to work in jobs that are more consistent with their
preferred hours; and (ii) workers are overcompensated for poor working conditions.
We provide two theoretical models that are more consistent with the
observed empirical patterns. The first is an equilibrium labor search model in
which a job is a package of wages and working hours, while the second is a
“rat-race” model in which professional employees are required to work inefficiently
long hours. Finally, we offer suggestions for offering more flexible jobs
(e.g., restricted regular employees) in the Japanese labor market.
