Internal Labour Markets Essay

The idea of an internal labour market was conceived by Kerr (1955), and perfected by Doeringer and Piore (1971).

Recently, more and more contributions by various experts are coming to light. Nevertheless, there are no unambiguous answers to the questions about the causes that have led to the origin of this concept which are fundamental in the field of labour economics.Most of the studies underline the efficiency-based explanations. They mainly consider the theories on risk aversion, efficiency wages, deferred compensation, specific human capital, and transaction costs as the basic reasons that have led firms, workers, and sometimes even governments to “choose” the new form of internal labour market to increase the efficiency level. Yet, there are other important reasons that warrant attention.The essay will attempt to define exactly to what extent internal labour markets (ILMs) are the consequence of a deliberate strategic choice. In order to achieve this objective I will first explain the basic characteristics of an internal labour market, starting from general debates on market segmentation and reviewing the most significant theories. Consequently, I will briefly describe what is presently happening to these markets.

Like so, I would like to emphasize my conviction that internal labour markets are of course, mainly, a consequence of deliberate strategic choices, encouraged by efficiency reasons, but also that initially they were largely affected by a number of other factors such as, trade union power, although this point needs clarification, government policies and the social-political-economic background.MARKET SEGMENTATIONTheories on labour market segmentation can be traced back to the contributions of a group of economists, who have criticised the traditional (classical and neoclassical), interpretation of how markets work, highlighting its gaps.According to traditional approaches, when markets are competitive, the “law of one price” is valid, which states that, in equilibrium, the same goods and services must have the same price. The Neoclassical theory is limited by the narrowness of its hypothesis, which does not allow the theory itself to explain its real phenomena.

On the other hand, segmentation theories emphasize the “fragmented” nature of the labour market and the importance of social and institutional factors on determining salaries and levels of employment. In practice, it shifts the emphasis from labour supply factors to labour demand factors. The main hypothesis of these theories is that salary differentials are not the result of different endowments of human capital, but rather a direct consequence of the “dual” nature of the labour market.In fact, the labour market does not have a unique identity. It consists of several markets divided into areas, generally poorly interconnected among each other. The causes of segmentation are of a different nature: territorial, informative, professional, racial, political, gender, technological, corporate, and cultural.The so-called institutional economists, supporters of the field of study known as “industrial relations”, have highlighted these peculiarities. Yet, the institutional approach has been often criticised because it emphasizes the importance of the explanation of phenomena, rather than its forecast.

Among these economists, Dunlop (1957) was the first to introduce concepts like “job clusters” in the firm and “wage contours” in the market, defined as the two mechanisms that correlate the internal salary structure with the one present in the external labour market.Kerr (1954) defines “institutional” as those markets in which the determination of salaries and employment levels is not simply the result of the interaction between workers and entrepreneurs, but rather it originates from rules, both formal and informal.Starting from these works, based on the concepts of internal and external markets, Doeringer and Piore developed the theory of Internal Labour Markets as an analytical instrument essential to understand the idea of duality in the labour market, particularly in fashion in the contest of the 60s, characterized by structural unemployment, technological changes and racial discrimination.

INTERNAL LABOUR MARKETSDoeringer and Piore (1971) define the internal labour market as “an administrative unit, such as a manufacturing plant, within which the pricing and allocation of labour is governed by a set of administrative rules and procedures”.In order to better understand the genesis of ILMs and the reasons why they exist we need to consider institutions as optimal answers to imperfections and weaknesses in the market. During the Fordism, due to a considerable economic growth in a number of countries, firms had to face structural tensions in the qualified job market and have been forced to develop strategies to bind the labour force to them.In a more general meaning, conditionings deriving from the training of the labour force contribute in explaining the origin of particular employment, promotion, and remuneration rules, which do not agree with the theoretical model of a competitive job market. Nonetheless, it is incorrect to reason only in terms of efficiency. Institutions are also the consequence of the interaction among different actors and their representation, especially in terms of equity.

Therefore it is appropriate also to consider the “political economy” of these institutions.The ModelA thorough explanation of internal labour markets requires the analysis of three factors: skill specificity, on-the-job training, and custom.In every firm, workers develop specific skills that can be used only within the firm itself. On the other hand, general skills can be used in a number of realities (Becker, 1962).

The effects of skill specificity are manifold:> It increases the percentage of expenses that has to be supported by the entrepreneur for the workers’ training, as those skills lose their value in the external market.; It increases total training costs.; It increases the value of internal training, inducing the firm to stabilize the relationship with the worker and to minimize turnover.; Costs related to human resources (screening, selection, etc) increase.

The advantage for the worker consists in defending their job from external competition.Directly related to skills’ specificity is ‘on-the-job’ training. It is described as being an informal process. This makes it difficult to spot its dynamics. Essentially, there are two basic elements: the presence of an instructor and “trial and error” learning.Finally, custom is the third indispensible component of the internal labour market theory. Custom is defined as “an unwritten set of rules based largely upon past practice or precedent” (Doeringer and Piore, 1971). It plays a decisive role in the determination of salaries, the internal flexibility, and the fixation of the quantitative and qualitative level of performance.

The origin of these unwritten rules, and the ethic value they assume, as well as the effectiveness of the system of sanctions, confer stability and rigidity to the internal market and protect it from economic external influences. However, the birth and development of these conditions do not necessarily stem from within the firm, but rather the legal, political and social background may affect it. Moreover, firms often favour accomplishing it as it enables a reduction in turnover costs.ILMs DESTABILIZATIONNow that the most important features of internal labour markets are clear, I will make a concise summary of the changes currently occurring in the market, so as to be better equipped later on in supporting my ideas regarding the causes of the origin of ILMs.In order to highlight the dependence of ILMs from the external situation, both economic-political and social, I will present some facts that describe the changes in action over the years up until now.During the last two decades a number of economic studies have coped with the issue of the increasing disparity in terms of salaries (mainly in the United States) and employment (chiefly in Europe), particularly concerning the deterioration of the less qualified workers market. The meeting of minds in the spotting of technological progress is largely responsible for this status. However, although it has played a crucial role, there are other evidences that explain the phenomena observed.

In fact, the destabilization of ILMs also derives from factors such as the slowdown in economic growth, globalization, intensification of competition, changes in funding modalities, and the new forms of labour organization. All these changes have borne considerable consequences in terms of salaries and jobs.Economic growth slowdownOn the one hand, economic growth has been one of the reasons of the birth of ILMs. With the purpose of facing the tension in the qualified job market, caused by economic growth, firms have had to define policies to bind them to the labour force. The slowdown in growth, leading to an increase in the unemployment level, has brought qualified labour force to its prime availability in the external market. As a result, this has weighed negatively on one of the most important incentives that favour the development of ILMs.

Financial changing and globalizationBecause IlMs is largely based on deferred compensation, it is necessary for their functioning to have a long and relatively foreseeable temporal horizon. Therefore, the huge increase in interest rates has had an effect to bear on the people involved (high interest rates mean a greater devaluation of the future and a larger preference for present incomes). Thus, the long-term logic, which is fundamental for ILMs, turns out to be weakened in its theory. Besides financial aspects, the globalization of the goods and services markets has resulted in greater competition.

Consequently, an increase of uncertainty for the firms in developed countries has occurred, thus led to the destabilization of ILMs.Technological progress and new forms of labour organizationTransformations both from the demand and supply side of the job market qualifications have contributed to render the logic of ILMs more and more precarious. On the ‘demand’ side, the technological progress and the new forms of labour organization demand more general skills from dependent workers. This has led to a devaluation of the traditional specific skills. In addition, new information and communication technologies have favoured the recourse to external flexibility, at the expense of internal flexibility. Whilst on the ‘supply’ side, in several European countries, especially in France, there has been a large increase in the level of education since the 1980s. This has furthered the decrease in the relative costs of external education (education acquired in the school) compared to the in-firm education (education acquired on the job).

The role of trade unionsAccording to Jacoby (1984), “when employment practices first achieved a semblance of rational organization, stability, and equity, these features were not a managerial innovation but were imposed from below, and the unions allocative, wage, and dismissal practices embedded the employment relationship in a web of personal, equitable rules…an internal labour market”. Taking into account this view, the internal labour market is not based on efficiency considerations but, rather, on equity, and requires unions for its enforcement.

Several data seem to confirm these observations, showing how the typical features of an internal labour market prevail in unionized firms rather than in non-unionized firms. As a consequence, decline in trade unions can be seen as a further weakening of ILMs.CONCLUSIONInternal labour markets are a within-firm market rather than an open market. The Internal labour market developed as an attempt to explain a number of empirical aspects of labour markets that attracted attention in the 1960s and 1970s.They have been mainly generated by three factors not envisioned in the conventional economic theory. Firstly, skill specificity. This resulted both from the requirements of technology employed in many firms, and the uniqueness of the jobs that individuals performed.

Secondly, on-the-job training. Training which is chiefly of an informal nature and which took on the form of ‘learning by doing’. One feature of this method of training is that the distinction between different jobs becomes blurred. Thirdly, custom. Custom at the workplace is an unwritten set of rules based largely upon past practices or precedent.

These rules can govern any aspect of the work relationship from discipline to compensation. Work customs appear to be the outgrowth of employment stability within the internal labor markets.However, internal labour markets are not only the consequence of a deliberate strategic choice made for efficiency reasons. Limits to this explanation come from the influence other factors have had on ILMs.One of these factors is the position governments have generally taken. I strongly believe that a more active role taken by governments could have limited the initial expansion of ILMs.

For example, some experts have claimed that if wage differentials do not correspond to supply and demand and to the net advantages of jobs, as so often occurs in the presence of ILMs, it would be better to establish new differentials via a comparable worth pay programme. Others specialists have claimed that if the market fails to establish a pay premium for dangerous jobs, again a feature of some ILMs, there should be a government regulation that imposes stricter safety standards and closer supervision. Whether these claims are justified or not, this logic in itself gives us reason to believe that governments have played a moderately accommodating role towards ILMs.An additional factor that should be considered is the power that trade unions have. The analysis of W.S. Siebert and J.

T. Addison in “Internal Labour Markets: Causes and Consequences” provides plenty of information on the importance of trade unions as a cause of the rise of ILMs. Yet, I believe that approach is erroneous to some extent. I am of the idea that trade unions were not decisive in the process of creating ILMs, rather, it is only natural that their role has been significant after ILMs came about. The existence of ILMs diminishes the role of exit as a mechanism for securing labour market adjustment and the voice mechanism is therefore prominent in this context.

We should therefore expect to find those institutions in the labour market associated with use of the voice mechanism represented here. This is exactly the case regarding trade unions.Finally, I think the political, social, and economic background has been a crucial factor. The relative decline in internal labour markets, shown in the text, leads us to the conclusion that the initial conditions were optimal for the expansion of the logic of ILMs. Nevertheless, after numerous structural changes in the labour markets over the last decades, it has become clear that internal labour markets were too dependent upon the surrounding situation to be considered simply as the result of a deliberate strategic choice.At this point, I think it is necessary to again cite the work by Siebert and Addison. They argued in their text, providing precise statistics, that the effect of internal labour markets has been considerably stronger in large companies than in small firms.

This agrees with our analysis, because the destabilization of ILMs occurred during a period within which small firms became prevalent in the market, at the expense of the traditional large companies. In conclusion, such analysis suggests that, perhaps, under different background circumstances, internal labour markets would have not been able to spread so to such a great extent.REFERENCESDoeringer, P. B. & Piore, M. Internal Labour Markets and Manpower Analysis, Sharpe, with new introduction, Part I, 1985Gregg, P.

and Wadsworth, J. “Job Tenure in Britain 1975-2000. Is a Job for Life or Just for Christmas?”, OBES, May 2002Marshall, R.C.

& Zarkin, G.A. “The Effect of Job Tenure on Wage Offers”, JLE, 5(3), July 1987Milgrom, P. R. & Roberts, J. Economics, Organisation and Management, Prentice-Hall, 1992 Chapters 10 &11Osterman, P.

(ed). Internal Labour Markets, MIT Press, 1984 , Chapters 1, 2 and 3Siebert, S. & Addison, J. “Internal Labour Markets: Causes and Consequences”, OXREP, 7 (1), Spring 1991


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