At various stages throughout the book, the discussion of work and pay in Japan is set against the background of several established theoretical concepts of the labour market. In many of the studies we consider, human capital theory is the dominant tool of analysis. It lies behind developments of such topics as the expected length of employment tenure, the shape of wage–tenure profiles, wage flexibility, the returns to schooling, and the business cycle behaviour of employment and working time. In order for the reader to achieve a firmer grasp of subsequent labour market discussion and empirical outcomes – as well as to progress further by referring to the labour market literature cited in the text – it is useful to become familiar with a few key theoretical developments. Fortunately, it is possible to cover a significant part of the field with recourse to a few, relatively simple human capital concepts. Beyond this, it is also worthwhile becoming aware of the importance of incentive-compatible wage contracts that do not, necessarily, incorporate human capital arguments. This chapter is designed to provide an introduction to this material in an accessible manner.

General and firm-speciffic human capital

Let us begin in the world of a textbook prot-maximising rm operating in competitive product and factor markets. We are interested in a short-run period for which the stock of capital is fixed.