QUARTERLY JOURNAL OF ECONOMICS sarily efficient. It may, however, be the only feasible way of providing third- party insurance; theoretically it is preferable that the govern idemnity to the firm when its profit is loy to the worker when his income is low. The government, however cannot always ascertain with precision the actual income or the op- portunity sets of individuals; what it insures, therefore, is not an ex ogenous event but an endogenous variable that is more readily ob servable, and that, under reasonable circumstances, is correlated with the exogenous event. This creates an important moral hazard prob lem 10 to which we shall return in Sections Iv and v nother source of problems for implicit contracts--which applies as well to the insurance literature but has even more force here- the enforceability of contracts. Implicit contracts are just that- mplicit--and one must ask what happens when either side deviates from the contract. Because the contracts are implicit, contracting parties may not have any legal recourse against breach Contracts lust thus either be self-enforcing or be enforced through tions To put the issue in plainer terms, let us focus on the worker: If his wage on average equals his marginal revenue product, what is to stop him from quitting in the good states, when his marginal revenue product is greater than his wage? The worker would thereby receive the benefits of the insurance offered by the firm (when the wage re ceived exceeds the value of his marginal revenue product), and would refuse to pay the insurance premiums. What is to stop him from reneging on his"“ implicit”’ contract? One early answer focused on the role of reputation: workers on contract might choose to reject outside offers at higher wages if, by doing so, they established a reputation for"reliability?"that would enable them subsequently to attract the preferential contracts handed out to“ reliable” workers The precise manner in which one acquires a particular reputation is rather hard to analyze Fortunately, we do not have to, for reputa tion is essential to the enforceability of implicit labor contracts only within the artificial confines of single-period contracts. Bengt Holmstrom demonstrates the point admirably in his paper"Equi librium Long- Term Labor Contracts"this ournal Holmstrom al lows workers to sign multiperiod contracts that they can abrogate at no cost after one period if they find a higher-paying job in the spot 10. A standard early reference on moral hazard is Arrow (1971 for a more recent Grossman (1977 was among the first to point out this problem6 QCARTERLY JOURNAL OF ECONOMICS sarily efficient. It may, however, be the only feasible way of providing third-party insurance; theoretically it is preferable that the govern￾ment pay a lump sum indemnity to the firm when its profit is low, or to the worker when his income is low. The government, however, cannot always ascertain with precision the actual income or the op￾portunity sets of individuals; what it insures, therefore, is not an ex￾ogenous event but an endogenous variable that is more readily ob￾servable, and that, under reasonable circumstances, is correlated with the exogenous event. This creates an important moral hazard prob￾lemlo to which we shall return in Sections IV and V. Another source of problems for implicit contracts-which applies as well to the insurance literature but has even more force here-is the enforceability of contracts. Implicit contracts are just that￾implicit-and one must ask what happens when either side deviates from the contract. Because the contracts are implicit, contracting parties may not have any legal recourse against breach. Contracts must thus either be self-enforcing or be enforced through reputa￾tions. To put the issue in plainer terms, let us focus on the worker: If his wage on average equals his marginal revenue product, what is to stop him from quitting in the good states, when his marginal revenue product is greater than his wage? The worker would thereby receive the benefits of the insurance offered by the firm (when the wage re￾ceived exceeds the value of his marginal revenue product), and would refuse to pay the insurance premiums. What is to stop him from reneging on his "implicit" contract? One early answer focused on the role of reputation: workers on contract might choose to reject outside offers at higher wages if, by doing so, they established a reputation for "reliability" that would enable them subsequently to attract the preferential contracts handed out to "reliable" workers. The precise manner in which one acquires a particular reputation is rather hard to analyze. Fortunately, we do not have to, for reputa￾tion is essential to the enforceability of implicit labor contracts only within the artificial confines of single-period contracts. Bengt Holmstrom demonstrates the point admirably in his paper "Equi￾librium Long-Term Labor Contracts" [this Journal].Holmstrom al￾lows workers to sign multiperiod contracts that they can abrogate at no cost after one period if they find a higher-paying job in the spot 10. A standard early reference on moral hazard is Arrow jl97lJ:tor a more recent treatment see Arnott and Stiglitz 11982). 11. H. Grossman [I9771 was among the first to point out this problem