CHAPTER FOUR
LABOR MARKET
By Birehanu K.
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Chapter Out Line
4.0. Introduction
4.1. Basic Concepts of Labor Market
4.2. Types of Labor Market
4.3. Theories of Labor Market
Policy Implications
4.4. The working of urban labor market in
developing countries
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4.0. Introduction
Labor market is the exchange of Labor or
Labor Power between suppliers(wage-earners
or employees) of labor, and
demanders(employers) of labor services.
Teachings of labor markets came into view
with the emergence of capitalism.
Capitalism is a stage in development that is
marked by production of goods & services for
the market.
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4.1. Concepts of Labor Market
Labor economics is the study of the workings
and outcomes of the market for labor
Labor economics is primarily concerned with
the behavior of employers and employees in
response to the incentives and non-pecuniary
aspects such as working conditions.
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4.1. Concepts of Labor Market
This is a reading assignment
Positive Economics
Scarcity
Rationality
Normative Economics
Market Value
Market Failure
Efficiency vs. Equity
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4.2. Types of Labor Market
Huge Job switching occurs in the labor market.
Individuals switch jobs for variety of reasons.
Broadly two types of labor markets exist:
1. Internal labor market
Found with a present employer
2. External labor market
Found at a new employer
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4.2.1. Internal Labor Market(ILM)
Advantage of ILM to the Employer
Minimizing cost of recruitment and training
by reducing labor turnover
May induce greater employee clarity with the
vision & goals of the organization.
High commitment and more effort, quality, &
other behaviors which enhance productivity
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4.2.1. Internal Labor Market(ILM)
Advantage of ILM to the Employee
Enhances job security & experience benefit
Increase opportunities for job training and
promotion
shielded from external labor market the competition
Generally, internal labor markets exist because it:
reduces hiring and training costs
improves employee morale and motivation,
reduces the effect of uncertainty
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4.3. Theories of Labor Market
Efficiency Wage Theory
States that employers may pay wages in excess of
market clearing wage rates because it results in
good incentives & beneficial productivity effects.
This theory explain the possibility that wage
increase may increase productivity.
An efficiency wage is one that minimizes an
employer’s wage cost per effective unit of labor
service employed.
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Discussion Question
How might firms deal with the
principal-agent problem when
supervision is costly and individual
output is difficult to measure?
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4.3. Theories of Labor Market :
Efficiency Wage Theory
Pay-for-performance plans are most capable of solving the
principal-agent problem when individual’s outputs are readily
measured.
When monitoring works is costly, the firm can pay on a piece
rate or a commission bases.
While performance is difficult to measure, bonus pay based on
team performance can be implemented.
Under competitive labor markets and homogeneous labor
inputs, market-clearing wage is the wage minimizes the firm’s
wage cost per effective unit of labor service
Under heterogeneous labor and wage-productivity, a firm can
lower its wage cost per effective unit of labor services by paying a
higher wage rate (efficiency wage).
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4.3. Theories of Labor Market :
Efficiency Wage Theory
Other efficiency models include:
shirking model,
Turnover model,
Superior Job Applicant model and
Fair Wages model
Discuss each of them
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4.3. Theories of Labor Market :
Efficiency Wage Theory
Shirking Model of Efficiency Wage
Theorizes that some enterprises pay more than the
market-clearing wage to reduce employees shirking
(do less work than agreed).
A higher wage operates as a pecuniary incentive
because a higher wage and unemployment rate
increase the cost of finding another job if fired.
Nutritional Model- in poor nations, an increase in
the real wage may elevate the nutritional & health
levels of workers; rise effort & efficiency
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4.3. Theories of Labor Market :
Efficiency Wage Theory
Labor Turnover Model- assumes that employers may
increase wages to reduce costly labor turnover, reduce their
replacement by new workers & thereby minimize training
costs.
Superior Job Applicant model-higher wage enable a firm to
attract a superior pool of job applicants. In a sense, this
helps employers to reduce the problem of adverse selection.
Fair Wages model-argue that workers proportionately
withdraw effort as their actual wage falls short of their fair
wage. Such behaviour causes unemployment and wage
differential.
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4.3. Theories of Labor Market :
Efficiency Wage Theory
Critiques on Efficiency Wage Theory
Efficiency wage theories produces several
interesting implications
It may lead to permanent unemployment
under conditions of labor market equilibrium
Trade offs exists
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4.3. Theories of Labor Market :
Human Capital Theory
is another dev’t of the competitive theory.
Human Capital is skills and knowledge, embodied in the
workforce.
It allows for the assumption that the workers are homogeneous
to be relaxed.
The theory focuses on compensation for the cost of investments
in education and training.
Human beings can increase their productive capacity through
greater education and skills training.
The higher a workers human capital endowment the higher the
wage earned.
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4.3. Theories of Labor Market:SLM
Segmented Theory of Labor Market (SLM)
its main hypothesis is that labor market is a combination of
a series of distinct interconnected markets rather than one
competitive market.
This distinction arises due to existence of barriers
determined by geographical, occupational institutional
factors and social attitudes to gender, race and age.
SLM theories were developed to explain inequality of
opportunity and persistence of poverty that remain as
prominent features of modern economies, and which
orthodox forces of competition failed to eliminate.
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4.3. Theories of Labor Market:SLM
Segmented Theory of Labor Market (SLM)
It is based on the Institutionalist approach and comprises
many diverse and overlapping models of labor markets
including
dual (primary, secondary),
tripartite (core, peripheral, irregular),
stratified,
hierarchical and
job competition model.
A fundamental dichotomy between internal and external
labor markets is related to dual and tripartite theories.
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4.3. Theories of Labor Market :SLM
Clark Kerr divided labor markets into two groups:
Structureless markets-which function like Neo-
classical competitive markets and where the only
attachment between employer and worker is the
wage rate, and
Structured markets- those on the inside enjoy more
favorable treatment than those on the outside.
Internal and external labor markets are an
example of a structured market.
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4.3. Theories of Labor Market :SLM
Dual Labor Market theory developed by Doeringer and
Piore (1980) is the simplest form of segmentation theory.
It is composed of two sectors: Primary sector & Secondary
sector.
Primary sector- is characterized by consisting of good jobs
with good wages, promotional opportunities, good working
conditions, job security, powerful trade unions and
consultancy style management.
The secondary sector- is characterized by having bad
insecure jobs, low wages, non-involvement of workers in
the decision-making process, poor working conditions and
un-unionized firms.
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4.3. Theories of Labor Market :SLM
Mobility b/n the two sectors is very limited,
resulting in a queue for primary sector jobs.
The sharp dichotomy b/n good &bad jobs in
the dual labor market model is too simple,
and
The distribution of the quality of jobs is more
likely to be multi-modal rather than bi-modal.
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4.3. Theories of Labor Market :JCM
Job Competition Model
Job Competition model developed by Lester Thurow (1976)
contributes the above argument.
It emphasises on the attributes of individuals and role of
training than wage
The function of the labor market in this theory is the
allocation of training slots.
On-the-job training is assumed to be the cheapest, most
efficient method of training.
Distribution of earnings is dependent on the distribution of
training slots.
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4.3. Theories of Labor Market
Summary
The level of competition vs. segmentation of labor markets is a
matter of degree.
Each market can be analyzed from one prospective or the other
as they are complementary .
The following summarises and highlights the key points.
Mobility-Relative mobility or immobility of labor is one of the
main points of contradiction between competitive and
segmentation theories.
Market Structure-Market structure is one of the most important
differences between competitive and segmented labor markets
theories
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4.3. Theories of Labor Market :sum
Human Capital- in competitive theory investments in Human Capital
play a very important role in determining the earnings and employment
opportunities of individuals
Exogeneity vs. Endogeneity of Tastes productive characteristics-
Competitive theories assume that tastes for education and acquiring
productive characteristics are exogenous
Negative Feedback Hypothesis -states that negative experiences of
workers may feed back into their performance or that of their offspring.
Efficiency, equity and policy considerations-the basic perfectly
competitive model of labor market assumes that equilibrium outcome is
efficient.
Equity vs. inequity of wage - Competitive theories also imply that the
competitive outcomes are equitable.
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Policy Implications
The policy implication of segmentation theories
are entirely d/t from those of competitive model.
According to segmentation theories, rather
than concentrating upon increasing the skills of
certain groups, policy should be aimed at job
distribution.
SLM representatives are policy-oriented,
advocating major changes in the economic
system in a left-liberal or socialistic direction.
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4.4. The Working Of Urban Labor Market in Developing Countries
In developing countries, the urban labor
market is characterized by
i. greater wage labour,
ii. greater formal sector employment,
iii. public and private sector
iv. urban self-employment (survivalist for the
majority);with d/t market forces interacting.
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4.4. The Working Of Urban Labor Market
in Developing Countries
The rural labor market is characterised by
agricultural employment and migration;
Agricultural work has many appearance include:
i. subsistence farming,
ii. co-operative farms,
iii. sharecropping
iv. tenant farming
v. large-scale farming where there is a clear
distinction between employers and employees.
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4.4. The Working Of Urban Labor Market
in Developing Countries
Arthur Lewis (1954) - the urban ( formal) wage
is greater than the rural (informal) wage for
three reasons:
Payoff to experience is greater in the formal
sector than the informal sector
Labour unions & minimum wages ensure higher
initial wages
Psychological cost of transferring from the easy
going life of the subsistence sector to the more
well-ordered environment of the capitalist sector.
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4.4. The Working Of Urban Labor Market
in Developing Countries
Theories show the existence of dualism in
urban labor market of LDCs along the line of:
formal and informal labor market.
1. What determines the informal sector of a
less developed country?
2. Are there any linkages between the formal
and informal sectors; e.g. can people
switch from one sector to the other easily?
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4.4. The Working Of Urban Labor Market
in Developing Countries
Determinants of the informal economy
Formal sector unemployment
Complicated/restrictive rules and regulations
Decline of civic virtue
in taxation in the formal sector
Empirical evidences show the presence of llittle
mobility between the formal and informal sectors.
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Informality Maters ?
What are the economic
consequences of being
informally employed?
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Effects of Informal Sector Employment
1. Job insecurity relative to formal sector
workers
2. Results in huge uncertainty which effects:
(a) household production and consumption decisions,
(b) human capital investment,
(c) returns to human capital (lower than in the formal
sector),
(d) reduce the likelihood of switching to formal sector
employment, ceteris paribus.
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Effects of Informal Sector Employment
3. Those unlucky workers employed in the
informal (secondary) sector will see their
likelihood of switching to the formal
(primary) sector decline with tenure in the
informal sector job;
this has implications for estimating & importantly
explaining wage differentials b/n identically
educated & skilled workers in the two sectors.
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In summary
Question ?
Comment ?
Thank You!
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