The New Palgrave Dictionary of Economics

Living Edition
| Editors: Palgrave Macmillan

Labour Markets

  • R. Tarling
Living reference work entry


The view taken of labour in the economic system is fundamental to economic theory. Classical writings accepted that the conceptualization of labour was a major issue in constructing theory and developed ideas in an area of the economics discipline which is now ‘political economy’. But labour in these early writings was regarded largely in terms of the individual, who by his very existence was part of a social, institutional and political system. How then could economics ever come to be seen to be remote from, or at least distinct from, sociology and political science?


Labour Market Collective Bargaining Labour Service Human Capital Theory Wage Determination 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

The view taken of labour in the economic system is fundamental to economic theory. Classical writings accepted that the conceptualization of labour was a major issue in constructing theory and developed ideas in an area of the economics discipline which is now ‘political economy’. But labour in these early writings was regarded largely in terms of the individual, who by his very existence was part of a social, institutional and political system. How then could economics ever come to be seen to be remote from, or at least distinct from, sociology and political science?

The simplest procedure by which theorists can achieve the distinction is to distinguish between labour input as a sequence of services performed and the individual within whom the ability to perform these services is embodied. The sphere of economics is then confined to the allocation of these services, taking the process of extraction of these services from individuals as an issue at the boundary of the discipline. In political economy, that process is crucial and perhaps best expressed in the Marxist construct of ‘labour power’. But neoclassical theory draws the line elsewhere: services are traded in an open market, just like any commodity, and individuals are presumed to offer to that market well-defined labour services. There is no extraction problem because the offers are voluntary, rationally chosen by each individual according to his utility of work.

This is then the most straightforward conceptualization of a labour market in which the services are traded as any commodity without reference to the source of these services. Markets will clear because marginal productivity theory allows the user to price the services and relate price and quantity while the suppliers of the services have a price governed by their utility preferences for work and can similarly trade-off price and quantity.

There is no difficulty in this theoretical framework in allowing for differentiation in the type of labour services. Some services may be quite distinct from others, so that we can talk about totally independent markets for the different groups of services. Alternatively, services may be more or less substitutable, for example combined with different amounts of physical capital, so that employers may select between a variety of combinations of labour services of different types. However, a unique solution is generally guaranteed by a ‘best practice’ technology which uniquely defines the demand for services of each type.

The more labour services are differentiated, the greater is the likelihood that there will be distinct markets for different kinds of labour services. This increases the possibility of resource bottlenecks and either markets which do not clear or which will only clear at very low or zero prices. Over time, the problem is resolved by human capital theory whereby investment takes place in those services which are in excess demand. A distinction is often made between general skills and firm-specific skills. However, in this context, the only relevance of the distinction is that it determines the size of the market in which the services are traded.

All of the problems for theory begin when we attempt to link the labour services with individuals who will provide these services. Each individual is capable of producing a range of services, not all of which may be required simultaneously. Few of these services will be instinctive, and will have required some period of learning, through formal or informal training or by experience. Human capital theory treats this process of training and skill acquisition as investment by the individual in a capability which can be taken to the market place and traded. There is a parallel with machines, where technology is embodied and a capability is taken to the market. But there are also some differences. The machine embodies technology which, in theory, is freely and readily available and inputs which will by assumption be available from the market. The individual has his native ability, which he will attain, and goes to the market to purchase inputs in the form of education, training and experience. However, his ability to realize his worth and to access the inputs depend on social organization and not on economic organization. Yet it can be asserted that the market will provide: that is, by assumption social organization is at least neutral and at best supportative of the market provision.

A rather more important factor is the cost of maintaining the capability to provide services. When machines are purchased as assets, the owner accepts a certain rate of physical depreciation and is responsible for maintenance and repair. An individual is rather more akin to a machine that is leased: a contract has to be negotiated for the responsibility for maintenance and repair, and for the rate of physical depreciation. Whether machines or individuals, there is an economically optimal rate of exploitation whereby the machine or individual survives to provide services at a later date.

Slavery would be the equivalent of a sale of assets but labour is accepted as being a lease contract. A feudal system was not as extreme as slavery, but embodied a contract which was somewhat disadvantageous to labour. On the other hand, under slavery the owner is wholly responsible for maintenance and reproduction of the provision of services, not the slave. The interpretation of labour as a leased asset in a market system is the other extreme, where labour itself is responsible for its own maintenance and reproduction. Thus, just as any commodity, labour has a supply price based on the costs of its own maintenance and reproduction.

There is a fundamental difference when it comes to the issues of getting the services performed. The ability to provide services is embodied in an individual and that individual contracts to provide the services over a particular period of time. So far there is no difference with a machine. However, the actual extraction of those services is a feature for which a machine has been designed: so long as the technical environment is appropriate, the machine will function according to its design. But an individual is not so easily switched on. It may be assumed that the individual can, and will, provide services voluntarily and to his full ability. That presumes a great deal about social organization. Individuals have free will, although they may be coerced, and attitudes and performance are heavily influenced by workplace and community relationships.

This leads into the major issue, that of collective behaviour. What distinguishes labour from other factors of production is that individuals can form groups based on common interests, common aims, common circumstances and common environments. These groupings may be transient or permanent, informal or institutional, and formed in the workplace or the community. Furthermore the groupings may be formed around conflicts of interest as much as commonality of interests.

It should be recognized that collective behaviour, as it impinges on the economic system, is not restricted to labour as a factor of production. It is an aspect of behaviour of all agents in the economic system, whether owners of natural resources, owners of purchased assets, employers and those responsible for the operation of institutions. The social relationships of the economic system are not simply a matter of the collective bargaining between labour and individual employers in individual workplaces but a matter of class, owner and employers groupings affecting not only the well-known aspects of collective bargaining but also capital markets, product markets and industrial structure.

Investment in human capital, the costs of maintenance and reproduction, and the process of extraction already pose problems for the application of a theory concerned only with the allocation of labour services. There have been many theoretical developments to cope with these problems, linking consumption and work, rational expectations and implicit contact theory. They do not however, cope with social relations as such and still leave collective behaviour as an imperfection in the market operation. That is, the individual is at best no more than a natural resource available for wealth creation when the system requires. However, unlike other natural resources, individuals only ‘lease’ themselves to the economic system so that not only are they conditioned by their social environment initially, they subsequentially continually interact with it.

Thus, social relationships are crucial not simply because they impinge on the way labour markets work, but also because they may play a major role in determining what labour markets actually are. Defining a labour market is not simply a question of selecting a group of homogenous services, with a given set of demands and supply. The question of the relation between services and the individual, the factors influencing the price of trading, and the factors affecting job definition and the access to jobs are all likely to redefine markets.

Multiple labour markets, which do or do not interact, are recognized in a number of theoretical formulations. Non-competing groups, occupational strata and technical skills may all underpin different labour markets, the issue of whether or not these markets would interact being determined by the nature of production relationships. One of the more popular versions of labour markets is that of the dual labour market. As originally conceived, a primary market was determined by technology and industrial organization, in which employers had a vested interest in creating labour markets with promotion ladders, investment in firm or technology specific skills and limited points of entry. Such ‘labour markets’ would be created at firm, industry or occupation level and would generate a limited stock of jobs with attractive terms and conditions of employment. The remainder of the labour force competed for less attractive jobs and mobility between sectors was determined by the stock of attractive jobs and personal characteristics of members of the labour force. There is a strong underlying technological determinism in the dual labour market framework, but it does recognize institutional forms and market (particularly oligopolistic) structures.

This view of labour markets does begin to address one of the most difficult aspects of labour markets because it recognizes a form of hierarchy in the employment structure. One of the properties of a market is that demands and supplies are taken to the market place for trading to take place whether this takes place continuously with the ‘invisible hand’ fixing the prices or at the beginning of each production/consumption period. However, one of the features of employment is that many individuals already have jobs and that they establish certain property rights in those jobs merely because they fill them. It is only the vacancies and new jobs which are offered to the market. Furthermore, these jobs which are vacant are numerically largely to be found in existing firms and industries in which particular labour conditions already exist. So, in practice, there are very few jobs which are offered in a totally unconstrained way. Equally, there are rarely new groups of labour coming onto the market: most are additional supplies of workers with differentiating characteristics whose existence tend to condition the market environment for new entry.

The major difficulty for a market interpretation is that these considerations suggest a division in the labour market rarely encountered elsewhere. New jobs and vacancies created by individuals leaving jobs which need to be filled are part of the determination of access to employment in jobs where the wage may or may not be predetermined. Within a firm or industry, wages are reviewed, individually or collectively, at far more frequent intervals than the jobs or their incumbents. On the other hand, vacancies are being created and filled all the time in the economy so that, potentially, there is a far more frequent review of wages in jobs at the margin.

The greater the hierarchical structure of the jobs the greater the importance to be attached to the process of accessing employment. Thus, wage negotiations for jobs at the margin (new ones and those changing hands) are more likely to be affected by considerations of access, so that who fills the jobs is just as important as how much they are to be paid in the job. On the other hand, the wage determination is likely to be of a conventional kind, with employers offering wages measured as ‘value for money’ in some sense and applicants having a supply price based on some wage aspirations related to consumption and the costs of maintaining and reproducing their ‘labour power’.

Wage determination for those in employment is likely to have wider scope, in that it will be more concerned with issues of extracting the labour services and with the wider aspects of the environment in which that extraction takes place. This suggests a divorce between the filling (and incumbency) of jobs and wage determination which greatly weakens the concept of a market for labour.

The two principal difficulties in the conceptualization of a labour market are the weakness of the direct link between the supply of labour and its price (seen either from the employers or the employees side) and the impact of social group formation on the processes within the labour market. At best, the employer’s demand could be expressed through a marginal productivity theory and labour supply through a theory of social reproduction. But, even then, the employer’s demand is influenced by social group formation, reflected through the evolution of institutions and industrial structure, and labour supply is influenced by social group formation, reflected through the evolution of institutions and household/community structures. These influences are dynamic in nature and continually restructure the definition of labour markets.

This raises major problems for theories of inflation. In a macroeconomic context, it may well be that all that is important is the total volume of employment demanded and supplied, and the average price of services employed. However, the processes by which those aggregates and averages are determined create a distribution of incomes between different groups of labour and households or social units, which in turn keep the distribution of incomes in a state of flux and hence the aggregates also in a state of flux. Similarly, the deployment of labour and the extraction of services forms a major input into the determination by productivity, and hence unit labour costs and prices. Prices also feed back into average real incomes. Changing prices, like the tax system, falls differentially on groups of labour or households, altering the distribution of real incomes and further complicating the analysis of the process of inflation.

There have been periods in economic and social history when structures have remained sufficiently stable for apparent separation of employment, wage determination and inflation theory. But analysis of periods of radical change have found existing theories wanting. The search for a general framework for labour markets must continue, but economists must remove their blinkers if they are to make a worthwhile contribution.

See Also

Copyright information

© The Author(s) 1987

Authors and Affiliations

  • R. Tarling
    • 1
  1. 1.