Current Issues in Labour Economics

It has long been recognised that the need for a ‘special’ theory of the labour market arises because of the ‘peculiar’ properties of labour which distinguish it from other commodities to which the usual theory of value may be applied (see, for example, Marshall, 1890; Hicks, 1932). Many important and exciting developments have taken place in the economics of the labour market over the past twenty-five years or so. Labour economics has by now established itself not only as a major subject in its own right, but also as one of considerable importance to the other main branches of economics, including both macro- and microeconomics. The purpose of the current volume is to provide readers with a coverage of the major recent developments which have occurred in labour economics, the majority of which have yet to find a place in set texts or other material readily accessible to students. Each chapter in this book has been specially prepared by an acknowledged expert in the relevant field, with the intention of providing both students and teachers of labour economics with a clear, comprehensive and up-to-date coverage of the topic in question. Our objective in this introductory chapter is to set the scene for the material which follows, by providing a brief overview of the major theoretical and empirical developments which have occurred in the subject over recent years.

The home-production approach to the analysis of household behaviour draws its origins from Gary Becker’s insight that market commodities are not consumed in their raw state,¹ but transformed into utility-giving final goods,² not transferable from one household to another, by the application of the consumer’s own time. For example, a meal at home requires various ingredients and appliances to prepare it, and time in which to prepare and consume it. We may, therefore, think of the good ‘home meal’ as having been produced by household members using as inputs market commodities and their own time. Such a product will have different characteristics and generally yield different utility from a restaurant meal. Typically, it will also have different monetary and time costs. Its costs and characteristics will also vary according to the number of people involved and to the relationship that exists among them: cooking for two is generally more efficient than cooking for one, and eating alone or in the company of strangers is not the same as sitting down to a family dinner!

This chapter studies the main results of the theory of search in labour markets. Since most work in the literature is concerned with job search by workers, this will also be our main concern. Perhaps because of the technical difficulties involved in formulating models of job search, all but the most elementary ideas associated with the approach are omitted from undergraduate labour-economics textbooks. This is a pity, since job-search models have proved a useful vehicle for the study of a variety of problems and, once the veneer of theoretical abstraction has been penetrated, the results are readily explained.

The origins of implicit-contract theory lie in the belief that observed movements in wages and employment cannot be adequately explained by a competitive spot labour-market in which wages are always equal to the marginal product of labour and the labour market is always in equilibrium.

While economists have had a long-standing interest in the way the presence of trade unions affects the operations of the labour market and hence of the economy, there has been a remarkable upsurge of work in this area since the late 1970s. This was undoubtedly sparked by the recognition that, given the prevalence of collectively negotiated wage agreements, a clear understanding of how unions set wages was an essential part of the urgent need to explain the prevailing very high levels of unemployment.

Why do strikes occur? This is a question which has attracted the attention of labour economists fairly intensively for at least the past six decades. This chapter provides a review of the economists’ analysis of strike activity, covering both the main theoretical models and the empirical evidence. The chapter begins with a brief review of the early (i.e. pre-1967) literature which, as we will see, focused its principal attention on questions regarding the existence and strength of cyclical fluctuations in strike activity. In section 6.3 we consider in some detail the more recent — primarily econometric — studies which first appeared in the US literature in the late 1960s. This approach spread fairly rapidly throughout the international literature as researchers in a wide range of countries adapted the basic model to suit their local institutional and other circumstances and fitted it, with varying degrees of success, to local data at various levels of aggregation. In section 6.4 we consider some of the important recent developments which have occurred in the economic analysis of strike activity, while the final section provides some concluding remarks.

During the past twenty years economists dissatisfied with orthodox theory have proposed different explanations of how labour markets operate. Some of the alternatives simply extend orthodoxy to include the effects of various institutional factors; others have explicitly sought a new paradigm. All reject a predominantly competitive analysis, insisting instead upon the fragmented nature of labour markets and the importance of institutional and social influences upon pay and employment. ‘Labour market segmentation’ (LMS) provides a common label for these alternative approaches.¹

The 1970s have seen many developments in macroeconomics, that have in many ways transformed the way in which open economies are analysed. Among these is an increasing emphasis on the role of relative prices like real wages (relative price of labour), competitiveness (relative price of imports), the relative price of oil, real interest rates and others.

Perhaps the most conspicuous evidence of malfunctioning in the labour market has been the ‘stagflation’ of recent years, in Western Europe and the USA. The problem has been so prolonged and so persisent that some analysts, in particular Martin Weitzman have become convinced that it can only be cured by altering the method by which pay is determined. In a number of forceful papers and a book (see Weitzman, 1984, 1985, 1986, 1987) Weitzman has proposed that governments should encourage the introduction of economy-wide profit-sharing to replace the traditional fixed-wage system. This proposal has attracted considerable interest, and was an important factor in the British government’s decision to subsidise profit-related pay (PRP) in the 1987 Finance Act. Our aim in this chapter is to review Weitzman’s proposals and the empirical evidence to date on the topic, as well as to consider the other effects of alternative remuneration systems.