The nature of labour markets and employment systems HR Management

The most general definition of the labour market is that it consists of workers who are looking for paid employment and employers who are seeking to fill vacancies. The amount of labour that is available to firms – labour supply – is determined by the number of people of working age who are in employment or seeking employment and the number of hours that they are willing to work.

This number will be determined by the size and age structure of the population and by the decisions made by individuals and households about the relative costs and benefits of taking paid employment. These decisions are influenced by various factors, one of which is the level of wages on offer.

Generally speaking, a higher wage will attract more people into the labour market and a lower wage will attract fewer as long as other factors, such the level of welfare benefits and people’s attitudes towards work, remain constant. The number of jobs on offer to workers – labour demand – is the sum of people in employment plus the number of vacancies waiting to be filled. The demand for labour is determined by the level of demand for the goods and services produced by firms in the market.

When sales and production are rising, firms’ demand for labour rises. When sales fall and production is cut back, firms’ demand for labour falls. The simplest view of the labour market is that it is an arena of competition. Workers enter the arena in search of jobs and employers enter it in search of workers. Competition between employers for workers and between workers for jobs results in a ‘market wage’ that adjusts to relative changes in labour demand and supply. Thus, when labour demand rises relative to labour supply, the market wage rises as firms try to outbid each other for scarce labour.

Nature and Characteristics of Labour Market

When labour demand falls relative to labour supply, the market wage falls as workers compete with each other for the smaller number of available jobs. Competition means that no individual firm can set a wage that is out of line with the competitive market wage. Neither can workers demand such a wage. Should a firm try to offer a wage that is below the market rate, it will be unable to hire workers. Should a firm set a wage above the market rate, it will go out of business because its costs of production will be above those of its competitors.

For the same reason, workers who demand a wage higher than the market rate will price themselves out of jobs. No firm will hire them because to do so would increase their costs of production relative to those of their competitors. While it is undeniable that competitive forces operate in the labour market to a degree, few would seriously pretend that this is a wholly accurate description of the real world. There are limits to competition between firms and among workers.

Empirical research has shown that rates of pay vary between firms in the same industry operating in the same local labour market (Nolan and Brown, 1983). Wages do not respond instantly to changes in labour demand. Employment policies vary considerably among firms. For example, some employ labour on a casual hire and fire basis while others offer long-term employment security and career development.

This has led labour economists to recognise that firms are not all equally influenced by the external labour market. Instead they develop a variety of employment systems which can be differentiated from each other in terms of the extent to which competitive labour market forces influence terms and conditions of employment.

Employment systems

Some of the most important contributors to the discussion of employment systems are Kerr (1954), Doeringer and Piore (1971) and Osterman (1984,1987). Their classifications of employment systems vary in terms of the number of different systems they identify and the labels that they attach to them. For clarity and brevity a threefold classification is developed here. Employment systems can be seen to vary in terms of the extent to which they are based on three different types of labour market. These are:

  • the open or unstructured external labour market;
  • the occupational labour market;
  • the internal labour market.

These types can be differentiated from each other in terms of how close they are to the basic competitive model of the labour market. This in turn can be examined in terms of where they lie along three conceptual axes:

  • External–Internal. The extent to which firms rely on external or internal sources of labour to fill vacancies.
  • Unstructured–Structured. The extent to which there are clear boundaries to the labour market in which the firm operates.
  • Competitively–Institutionally regulated. The extent to which entry to jobs, progression within and between jobs, and terms and conditions of employment are determined by market competition or by formal rules

Administered through internal institutions (i.e. institutions developed by workers and employers) in addition to statutory protections afforded by the law. Employment systems that are closest to the basic competitive model will be external, unstructured and competitively regulated. Those furthest from it will be internal, structured and institutionally regulated.

  • The open external labour market

    This corresponds most closely to the simple model of the labour market as an arena of competition. It is external in the sense that employers draw their labour from an external pool and do not seek to foster long-term employment relationships. Workers are hired and fired as needed. It is also unstructured because there are no clear occupational boundaries within it and it is easy for workers to enter the market and move from job to job because no prior training or qualifications are necessary.

    Furthermore, there is little institutional regulation in the open external labour market. Workers have few legal rights or protections and trade unions are weak or non-existent. Therefore workers compete with each other for employment and employers determine the level of wages in the light of how abundant or scarce labour is in the market. This means that employees are continually exposed to external market forces.

  • The occupational labour market

    Occupational labour markets arise where workers have skills that can be transferred from one firm to another. Labour markets for professional workers are often of this type; for example, doctors can work in different hospitals, teachers can move from one school to another and lawyers from one law firm to another without having to retrain. Occupational labour markets are external in the sense that, because workers’ skills are transferable across firms, employers can fill vacancies by drawing on the pool of qualified workers that exists outside the firm.

    Workers can also look to further their careers by moving from one firm to another in search of promotion and better opportunities. Clearly there is potentially an element of competition in the occupational labour market. However, unlike workers in the open external labour market, those in structured occupational labour markets are able to insulate themselves from pressures of labour market competition to a considerable extent.

    Many analysts, following Kerr (1954), have argued that this means that the structured occupational labour market has been internalised to a degree, since it operates on the basis of rules generated internally within the occupation rather than being ruled by open competition. The reasons for this are as follows. Occupational labour markets are structured on an occupational basis, with occupational boundaries being defined in terms of the tools or materials used, or skills and qualifications. Movement between occupations is therefore difficult because of the time and expense involved in retraining to obtain a new set of occupational qualifications.

    This limits the extent to which workers in an occupation are exposed to competition from workers outside it. This in turn enables workers to act collectively to influence their terms and conditions of employment through institutional regulation rather than leaving them to be determined by competitive market forces. Professional associations or trade unions control entry to the occupation, for example by making the right to work in it conditional on having certain minimum qualifications.

    Control of entry means that the number of workers can be restricted. This limits competition further and means that those in the occupation are ensured of employment. It also gives trade unions and professional associations a measure of bargaining power, which they can use through negotiation with employers to regulate pay and conditions.

  • The internal labour market

    Internal labour markets are essentially enterprise-based employment systems. In other words, terms and conditions of employment are determined by rules that are internal to the organisation rather than by competitive forces in the wider labour market. They are internal in the sense that external recruitment is limited to junior and trainee positions within the organisation. Other vacancies are filled through internal transfers and promotion. Skills are learned on the job and are specific to the organisation in which they are acquired, rather than being transferable across firms.

    This restricts the mobility of workers between firms, since the skills learned in one organisation are not equally useful in another. Workforce reductions are achieved through ‘natural wastage’, that is by nonreplacement of workers who leave, rather than by dismissals. Therefore there is a high degree of long-term employment security for workers. Internal labour markets are also highly structured in that they consist of hierarchies of jobs that are graded in relation to each other in terms of skill, responsibility and pay.

    Job hierarchies are also designed to provide career progression paths or ‘job ladders’ that provide opportunities for internal transfer and promotion and so retain and motivate trained workers. Workers can climb job ladders by acquiring training and experience in lower -level jobs that prepare them for the next rung on the ladder. In practice, promotion is often based on length of service in a lower-level job. Internal labour markets are subject to a high degree of internal institutional regulation.

    This takes the form of bureaucratic, administrative rules that define the content of jobs, order the place of jobs in the job hierarchy, establish rules for promotion and set rates of pay for jobs(see Marsden, 1999). This results in a pay structure that reflects the different levels of skill and responsibility that attach to jobs as workers move up the job ladder. Such pay structures are unresponsive to pressures from the external labour market. Firms are reluctant to alter wage rates for particular jobs even when their demand for labour in these jobs falls or when they face labour shortages, because to do so would risk upsetting the entire pay structure.

    There may also be rules that regulate management’s ability to dismiss workers should this become unavoidable. A common example is the ‘last in, first out’ or seniority rule whereby it is those with the shortest length of service who ar first selected for dismissal. In practice, internal labour markets vary in terms of the opportunities for internal promotion that they offer and the strength of their guarantee of long-term employment security. Empirical research has found that internal labour markets are more highly developed for technical and administrative workers in these respects than for manual workers (George and Shorey, 1985; Osterman, 1987).

    Therefore we can identify two variants of internal labour market: the salaried internal labour market (technical and administrative workers) and the industrial internal labour market (manual workers) (Osterman, 1987). Long-term employment security, structured career paths and opportunities for internal promotion are more highly developed in the salaried internal labour market than in the industrial internal labour market. This has led some to argue that the industrial internal labour market should be seen as a fourth type of employment system rather than as a variant of the internal labour market (Hendry, 1995).

    In reality, firms’ employment practices do not fit neatly into these categories. Firms that wish to keep employment costs low frequently draw back from casualised employment and the extremes of the open external labour market because they fear that it will demoralise workers and undermine the quality of production or service delivery. Firms that operate in occupational labour markets often seek to retain existing employees as they value their experience and it is not always easy to replace workers when they leave.

    This leads them to move, to some degree at least, in the direction of the internal labour market. Furthermore, the example of the industrial internal labour market above also shows that many organisations tend towards an employment system without conforming to it completely. It is clear that the employment policies of particular organizations cannot always be fitted exactly into one of the three employment system ‘boxes’ outlined above.

    It has also been argued that more than one employment system may exist within the same firm: a salaried internal labour market for managerial, administrative and technical staff, occupational labour markets for skilled production workers and open external labour markets for unskilled workers (Adnett, 1989).

    Therefore the categories of open external labour markets, structured occupational labour markets and internal labour markets are probably best seen as ideal types, that is, as conceptual categories that help to organise our thinking, rather than as completely accurate empirical categories into which organisations can be slotted neatly and unambiguously. The next section of this chapter looks at the factors that encourage employing organisations to internalise or externalise their employment systems.


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