Labor Demand

BIBLIOGRAPHY

The “demand for labor” is usually understood by economists to mean the demand for labor services by a firm, an industry, or the economy at a given real wage. In a capitalist economy, labor becomes a commodity that is bought and sold on the market just like any other commodity, such as bread or butter. Labor is a unique commodity, however, and when an employer buys labor, he or she obtains a worker’s “labor power” which is the amount of services that the employer gets from the worker. These services depend on the power the employer has over the worker. If there is high unemployment, for example, the worker is in a weak position and greater labor services can be extracted from him or her. The amount of labor services that the employer obtains (not only in terms of hours of work, but in terms of the efficiency of those services) also depends on the nature of the employment contract, the real wage paid to the worker, the conditions of employment, and the attitude of the employer to the worker (and vice versa).

Labor services consist of three components: the number of workers (employees), the average hours worked per worker, and the efficiency per hour of the worker. There are several institutional and legal constraints on employers in most developed countries. For example, there may be laws against discrimination, equal pay legislation, minimum wages (henceforth, the term wages refer to real wages), occupational health and safety requirements, hiring and firing restrictions, and penalty rates for overtime.

The demand for labor is a derived demand: Firms wish to hire workers to produce goods and services that they sell in order to earn profits. Alfred Marshall, in his Principles of Economics (1930) suggested that labor demand becomes more responsive to wage changes if the substitution possibilities between labor and capital increase. In other words, the easier it is to substitute capital for labor, the greater the share of wages in total costs, and the more responsive the other factors of production are to their prices.

Much of the formal economics literature is based on simple models of firm behavior in a perfectly competitive economy (for a closed economy, that is, without any international trade), assuming that labor is a homogeneous commodity. In a prototype model, a firm is assumed to maximize profits (or minimize costs) subject to a so-called “well-behaved” production function that depends on homogeneous labor and capital. By simple mathematical manipulation, it is easy to show that the firm’s demand for labor is a negatively sloped marginal revenue product (MRP) curve, and that employment is determined by equating the marginal revenue product of labor with the wage rate. In such models, it is usually assumed that labor and capital are substitutable (usually in a Cobb-Douglas production function). There are some difficulties, however, in moving from a firm labor-demand function to an industry or aggregate labor-demand function because of the possible interactions between firms, the heterogeneity of labor, and other factors.

In most of these models, it is assumed that the technology of production is given and unchanging. Alternatively, technological change is simply an exogenous variable that falls like manna from heaven on all existing inputs. Labor services are often assumed to be such that hours of work and employees are perfectly substitutable.

The impact of technological change on the labor market and on labor mobility is very significant, but it often has contradictory effects. Technological change is usually defined as being either a change in the product or a change in the process of production. Technological change that leads to the introduction of new products will lead to either new firms being set up or old firms expanding into a new product line, which would lead to increased employment through job creation and job destruction. Job destruction leads to the closing down of firms producing some products that are replaced by new firms producing new products. However, demand for a new product may lessen demand for competing products, leading to a reduction in labor demand elsewhere in the economy. Similarly, a technological change in the production process may lead to the substitution of capital for unskilled labor, and hence to a decrease in labor demand. It may also lead to an increase in the demand for skilled labor, however, due to a complementarity of capital with skilled labor.

In more advanced models, labor is treated as a “quasi-fixed” input, like a capital good (see Oi 1962; Nickell 1986). In other words, there are significant fixed costs associated with changing employment, due to hiring and firing costs. Usually, it is assumed that these costs of adjustment are quadratic (implying increasing marginal costs of adjustment), so that if there is an increase in the demand for goods the impact on the demand for labor is spread out over a few periods. In the short run, the demand for labor adjusts slowly in response to any external shock. Given that there are costs of adjustment, the firm would find it easier to either adjust the hours of work of existing workers or hire casual part-time workers. It is cheaper, however, to hire and fire casual part-time workers. European countries that have a more regulated labor market, with larger hiring and firing costs, have been found to have a slower adjustment process to shocks. However, the evidence on this is very controversial and needs further research (see Blanchard 2006).

There has been a large amount of econometric work to estimate the impact of a change in real wage rates (corrected for inflation) on labor demand holding the level of production constant using large datasets. Most of these studies have found that elasticity (the percentage change in labor demand in response to a 1 percent change in the real wage rate) lies between –0.15 and –0.75, with “a best guess” of –0.30. However, studies of the impact of minimum wages on employment suggest that there is no significant impact (see Card and Krueger 1995). David Neumark and William Wascher have found otherwise, however, perhaps because it is mainly unskilled labor, while usual studies of labor demand are for skilled and unskilled labor taken as a whole. The scale elasticity (i.e., the impact of increased output) is almost unity: a 1 percent increase in the level of production (output) leads to a 1 percent increase in labor demand.

Firms demand labor services from employees who provide honest, committed, and productive work at wage rates that the employer determines (either unilaterally or as a bargain between the employer and employee). Ideally, employers would like to employ workers who take a positive long-term interest in their work and make useful suggestions to improve the production process. In general, firms have flexibility in the wage (and other conditions of work, including perquisites) they offer to their employees. There are also theories of deferred payment, tournaments to provide a stimulus to get wage increases, and “efficiency wages.” It has been shown that employers can get higher productivity from their workers, and hence make higher profits, if they pay a higher real wage. This idea was first put forward in a classic paper by Harvey Leibenstein (1957), who argued that in a developing country, paying higher wages led to workers getting better nutrition and providing better productivity.

This essential link between wages and productivity, or “efficiency wages,” was extended in a series of papers: In 1984, Carl Shapiro and Joseph Stiglitz put forward the view that higher wages decreased shirking by employees; Steven Salop argued in 1979 that higher wages lowered worker turnover, increased productivity, and increased profits; and Andrew Weiss (in 1980) and George Akerlof (in 1982) both showed that if employers paid higher wages as a partial gift, workers would reciprocate by providing greater effort. Thus, there is no unique negative relationship between the real wage and employment, because an employer who pays a wage in excess of the “market wage” gets greater productivity. Lowering the wage does not increase employment. Experimental economics, particularly the work of Ernst Fehr and Simon Gächter, has shown the importance of considerations of “reciprocity” (e.g., fairness, equity, and other issues) in the employment relationship.

In a globalized world, the demand for labor becomes more confused as various activities are “outsourced.” In other words, the firm can produce a larger quantity of output by either hiring more labor, buying more capital goods, improving its technology, or simply by outsourcing a particular activity. Call centers in less developed countries are good examples of this. Hence, the link between the output of a firm and its demand for labor is no longer constrained by a given production function.

There has been a large amount of econometric analyses of the demand for labor, suggesting, in general, a negative link between wages and employment. There are important policy implications that can flow from the research about minimum wages, but the results are contradictory and controversial (see Card and Krueger 1995; Neumark and Wascher 1992). Similarly, the efficiency wage literature also throws some doubt on a simple negative relation between wages and employment. The literature on hiring and firing costs has been used to suggest that a deregulated labor market would lead to higher employment, but this is still being debated.

SEE ALSO Economics, Labor; Employment; Labor; Labor Force Participation; Labor, Marginal Product of; Labor Market; Labor Market Segmentation; Labor Supply; Wages

BIBLIOGRAPHY

Akerlof, George A. 1982. Labor Contracts as Partial Gift Exchange. Quarterly Journal of Economics 97 (4): 543–569.

Akerlof, George A., and Janet L. Yellen, eds. 1986. Efficiency Wage Models of the Labor Market. Cambridge, U.K.: Cambridge University Press.

Blanchard, Olivier. 2006. European Unemployment: The Evolution of Facts and Ideas. Economic Policy 21 (45): 5–59.

Card, David, and Alan B. Krueger. 1995. Myth and Measurement: The New Economics of the Minimum Wage. Princeton, NJ: Princeton University Press.

Fehr, Ernst, and Simon Gächter. 2000. Fairness and Retaliation: The Economics of Reciprocity. Journal of Economic Perspectives 14 (3): 159–181.

Griliches, Zvi 1969. Capital-Skill Complementarity. Review of Economics and Statistics 51 (4): 465–468.

Hamermesh, Daniel S. 1993. Labor Demand. Princeton, NJ: Princeton University Press.

Junankar, P. N. 1982. Marx’s Economics. Oxford: Philip Allan.

Lazear, Edward P. 1995. Personnel Economics. Cambridge, MA: MIT Press.

Leibenstein, Harvey. 1957. The Theory of Underemployment in Backward Economies. Journal of Political Economy 65 (2): 91–103.

Marshall, Alfred. 1930. Principles of Economics. 8th ed. London: Macmillan.

Marx, Karl 1867. Capital. Vol. 1. London: Lawrence and Wishart, 1977.

Neumark, David, and William Wascher. 1992. Employment Effects of Minimum and Subminimum Wages. Industrial and Labor Relations Review 46 (1): 55–81.

Nickell, Stephen. 1986. Dynamic Models of Labor Demand. In Handbook of Labor Economics, Vol.1, ed. Orley C. Ashenfelter, and Richard Layard. Amsterdam: North Holland.

Oi, Walter J. 1962. Labor as a Quasi-Fixed Factor. Journal of Political Economy 70 (6): 538–555.

Salop, Steven. 1979. A Model of the Natural Rate of Unemployment. American Economic Review 69 (1): 117–125.

Shapiro, Carl, and Joseph Stiglitz. 1984. Equilibrium Unemployment as a Worker Discipline Device. American Economic Review 74 (3): 433–444.

Solow, Robert. 1990. The Labor Market as a Social Institution. Oxford, U.K.: Blackwell.

Weiss, Andrew. 1980. Job Queues and Layoffs in Labor Markets with Flexible Wages. Journal of Political Economy 88 (3): 526–538.

P. N. Junankar

labour-market In a labour-market, human effort (or labour power) is made into a commodity, which is bought and sold under terms which in law are deemed to constitute a contract. The purchase and sale of formally free labour developed extensively with capitalism, but alternative paths to industrialization (such as real socialism) have entailed wage employment, though not strictly a free market for labour. Economists argue that, as with other factors of production, the market for labour can be understood as a special case of the general theory of prices, with the price (wages or salaries) being determined by supply and demand. However, research on actual labour-markets has shown that, in practice, many of the basic conditions assumed by price theory are usually absent. Mobility of workers between jobs is often sluggish or non-existent; the anarchic structure of earnings differentials bears only the loosest relation to labour supply and demand; discrimination, labelling, racism, and sexism are rife. Economic explanations of labour-market processes have to be supplemented, and sometimes replaced, by sociological analysis, creating a promising field for interdisciplinary research.

Neo-classical economic theory views exchanges in the labour-market as voluntary, and engaged in because, for each party, the results of the exchange are better than their other options. The labour-market is a competitive market because there are many potential buyers for each seller and vice versa. The supply of labour from existing and potential workers and the demand for labour from employers interact so as to reach an equilibrium price for labour. If the price of labour rises above equilibrium level for any reason, for example due to a national minimum wage or strong trade-union bargaining, employers will reduce the number of jobs offered. If the price of labour falls, employers will increase the number of jobs offered, all other things being equal. Economic theory of the labour-market also posits that both monopolies and discrimination will disappear in the long run, and are thus unlikely to be enduring constraints to individuals. On the other hand, economic models of the labour-market see workers forming a queue for the available jobs, with employers choosing the best first: people with higher qualifications, more experience, and wider skills will be offered jobs before those with less to offer. It follows that the unemployed will always consist of those with few or no qualifications, fewest skills, and least employment experience; and that people with social, psychological, or other problems will be less readily hired. So the model allows for certain forms of rational discrimination.

Many economic models assume that people have perfect information with which to make rational decisions within given constraints, and adjust their offer and demand prices accordingly. Empirical research has persuaded some economists to recognize that information gathering and analysis are costly in time and money, so that market imperfections arise from incomplete or inadequate information, and satisficing models are accepted as more realistic than maximizing models of behaviour.

Basic to sociological studies of labour-markets is the recognition that, although labour effort is nominally bought and sold, it lacks many of the attributes of other commodities in the capitalist economy. These differences in turn go some way to explaining why the market for labour presents such a confusing picture to the price theorist. At least four factors should be considered here.

First, like any service which is bought, there is scope for ambiguity about what precisely constitutes a satisfactory amount of work (or effort) done in fulfilment of the contract. Ambiguity about what constitutes a fair day's work for a fair day's pay is endemic, especially if there are frequent changes in work tasks. Because this effort bargaining occurs in even the most routine work situations, then values, custom and practice, administrative rules, and the relative power of employer and employees, are all equally as important as the price mechanism in shaping labour-market outcomes.

Second, inequality of wages and conditions reflects the level of organization of the workforce, as well as market competition. Though in legal theory a contract of sale assumes equality of both parties to it, this is inconsistent with the power inequality usual between any worker negotiating individually, and a potential employer. Consequently, in a wide variety of situations and nations since the onset of industrialism, workers have sought to offset this by forming trade unions. Collective bargaining, when it occurs, undermines standard notions of a market by replacing wage-fixing through the price mechanism by wage-fixing through rules. It also brings law and politics into the regulation of labour matters. The acceptability of collective labour contracts and wage-fixing agreements tends to be a potentially destabilizing political issue everywhere in the industrialized world, as is the legality of the unions and associations which represent the collective worker, to say nothing of the sanctions and stratagems used by both sides during the course of industrial conflict. Most societies have therefore sought to surround the labour-market with a body of law and politico-administrative control.

Third, both unions and employers frequently seek to create so-called internal labour-markets: that is, networks and hierarchies of jobs to which access is restricted by entry rules and internal promotion. For example, by enforcing job-entry controls, unions can restrict access to craft training and relatively favourable wages and conditions. Employers likewise can segment their demand for labour by varying benefits and promotion, seeking to reward and retain valued workers, while offering others only non-standard or flexible employment. (Some scholars also claim that internal markets based partly on discrimination and wider prejudice help employers to divide and rule the workplace.) Family and neighbourhood networks frequently reinforce exclusiveness of job access outside the actual workplace, producing extended internal labour-markets.

Fourth, there remain many industries and situations where workers are relatively powerless and unorganized, so that pay and conditions can be expected to be less favourable than if workers use their collective strength. Union organization has typically been found to be difficult among workers in small-firm industries, in the retailing and personal services sector, in part-time and subcontracted labour, and among women, ethnic minorities, and young people. Isolation and powerlessness do much to explain the common research finding of widespread low pay and insecurity of work among such groups.

For some years, so-called dual labour-market theory claimed that labour-markets can be divided into a primary sector, consisting of relatively well-paid internal labour-market jobs; and a secondary sector, comprised of more insecure low-wage employment, which does more closely resemble the competitive model. Theory of this type has encouraged collaborations between those sociologists and economists who are prepared to question the preconceptions of both disciplines. But empirical research by both economists and sociologists suggests that the anomalies and segmentation of labour-markets cannot be accommodated easily into a simple dualism, and is leading to the development of more complex, multi-disciplinary approaches (such as labour-market segmentation theory).

One major form of dualism in the labour-market, however, is well documented if not wholly understood: the persistent divisions in pay, conditions, and types of work between men's and women's employment. For example, economists predicted that equal pay legislation would increase the relative price of female labour, and thus reduce the number of women's jobs offered by employers. In fact, total female employment rose at the same time as the rise in female earnings resulting from equal pay rules. These trends can perhaps be explained by seeing the labour-market as divided into a number of separate markets—for female labour, manual labour, young untrained school-leavers, older workers, professional workers, and so forth—with limited competition between labour-markets. The most developed versions of this theoretical refinement are found in labour-market segmentation theory.

In general terms, therefore, the sociologist's most important contribution to labour-market theory is to identify the cultural, institutional, and structural factors that help determine people's allocation to one or another market, the imperfections of market processes, the reward systems operating in different markets, and the nature of power relationships in the market. Jill Rubery 's essay on ‘Employers and the Labour Market’ (in D. Gallie ( ed.) , Employment in Britain, 1988
) reviews the various theories of labour-markets, examines the evidence for flexible employment, and contains a good bibliography of British and American case-studies. For examples of empirical analyses see Jill Rubery and and Frank Wilkinson ( eds.) , Employer Strategy and the Labour Market (1994
). See also DIVISION OF LABOUR; HUMAN-CAPITAL THEORY; OCCUPATIONAL SEGREGATION.

labour services were tasks undertaken by tenants as part of their obligations to landowners for the right to farm or use land. These duties came to be seen as part of the rent paid by tenants under the ‘manorial system’ during the Middle Ages. One of the definitions of villein status was performing labour services at the will of the lord because, in theory, the obligations were unrestricted. In practice, the levying of labour services depended on the farming regime of the lord of the manor. When cash crops were especially profitable, as during the 13th cent., lords of the manor increased their directly farmed demesne land and used labour services to take advantage of good weather conditions: for spreading manure, ploughing the arable, repairing and maintaining boundaries and ditches, gathering crops of hay and grain, and carrying them to barns or markets.

Precise statements of labour services owed by landholders to the lord of the manor were set out in ‘custumals’, documents produced in manorial courts under oath. Villeins, tenants of the lord of the manor, resisted attempts to extend labour services. During the 14th cent. landowners found it profitable to commute labour services for fixed cash payments. Declining demesne farming by landowners after the middle of the 14th cent. reduced labour services and they ceased to be a determinant of social status by the 16th cent. A few labour services survived in economically underdeveloped areas until the early 18th cent., as in parts of rural west Lancashire.

Ian John Ernest Keil

labour-market flexibility A term used to refer to all or some of a variety of features of particular jobs, or of the labour-market as a whole, including: reduced demarcations between categories of worker and flexible job descriptions; the fluidity of workers' movement between jobs, employers, or regions; flexible or non-standard work hours; flexibility of wages; and any other innovation in the organization of employment and patterns of work, such as home-based work, or telecommuting. In this context, wage flexibility more often means wages that rise or fluctuate in line with company profits and financial performance, than the adoption of incentive payment schemes. The concept of flexibility is often laden with positive value-judgements and counterpoised to the notion of labour-market ‘rigidities’, which are regarded as self-evidently noxious in periods of rapid technological change and economic instability. See also FLEXIBLE EMPLOYMENT; JAPANIZATION.

labour services were tasks undertaken by tenants as part of their obligations to landowners for the right to farm or use land. These duties came to be seen as part of the rent paid by tenants under the ‘manorial system’ during the Middle Ages. One of the definitions of villein status was performing labour services. Precise statements of labour services owed by landholders were set out in ‘custumals’, documents produced in manorial courts under oath. During the 14th cent. landowners found it profitable to commute labour services for fixed cash payments. A few labour services survived in economically underdeveloped areas until the early 18th cent.

flexibility, labour-market See LABOUR-MARKET FLEXIBILITY.