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Needed: an interdisciplinary approach to labor markets and wage determination.

An understanding of the reality of wage determination and labor markets--apart from collective bargaining--requires, in my view, a conceptual blend of industrial relations and economics. Policy prescriptions to be listened to and

to be effective likewise need to proceed from an integration of the two disciplines.

Economics must appreciate that wage rates are but one rule of the workplace among a vast array of rules. There are no fixed terms or rates of substitution with other rules, or even with other compensation rules. All terms of employment are not reducible to money. Industrial relations specialists likewise need to recognize, as should economists, how the complex of rules of the workplace is influenced, both in static and dynamic terms, by the contexts of technology, labor and product markets, and political power in the large society--not by conventional labor markets alone.

The fact is that the mainstream of economics has always qualified and tempered its analysis of wage determination and labor markets by recognizing that special and peculiar features are at work that do not permit the unrestrained application of competitive theory, as applied to other markets. However, the readily observable facts of umemployment and differentials in compensation in the same markets have encouraged, in the past 10 or 15 years particularly, an extensive intellectual effort and considerable ingenuity among microeconomists to find explanations within the framework of economic rationality. These various attempts are not likely to impress industrial relations specialists. The judgment is likely to be that the models are far too esoteric. They apply to few situations, and they will not take us very far toward a general view of labor market and wage behavior. The amendments to microeconomics are not adequate to the magnitude of the gap between the competitive model and reality.

The 'real world'

I consider three concepts that have their roots in industrial relations and practical experience as essential to an understanding of wage determination and the operation of labor markets. They are not congenial to microeconomic theory.

1. Internal labor markets. An essential tool is the internal labor market, as distinguished from the conventional or "external" labor market. The BLS monthly household survey reports persons as outside the labor force, as employed, or as unemployed and seeking work during the survey period.

Movement among these categories defines gross changes in employment and unemployment. All these changes constitute movement among enterprises or labor force states. These movements arise in the external labor market, a minute fraction of the complex of movements that take place each day.

The internal labor market is an administrative unit in which movements within the unit or with the outside are patterned by formal rules or customs. The unit may involve only some job classifications of an establishment or may halls or multi-plants of a single company. The internal market may be narrow, involving a single enterprise, or be very broad as in the civil service system of governments.

Internal labor markets are concerned with such tropics as seniority, seniority districts, retirement policies, hiring and recruitment standards, promotion rules, layoff criteria, absentee policy, health care regulations, equal employment opportunity, and age or handicap discrimination, as well as procedures for dispute resolution over these rules and their consequences for management, employees, and labor organizations.

The internal labor market is the unit within which relative wage rates are also determined among job classifications, not among individuals, with the aid of job evaluation or incentive systems or by decisions exercised by management or through collective bargaining. These relative compensation rates are peculiarly the social concerns that are so important in the mainstream of economic thought, as evident in the work of John R. Hicks and others. The internal alignment of rates likewise needs to be related to some external rates, particularly for some job classifications.

Internal labor markets and their rules that govern the movement of workers are also the fundamental determinants of the quality of the work force and the training that is acquired over a period of time on the job. Thus, the flexibility of the work force, its adaptability to technical change, to shifts in work processes, to new quality and work standards, and to new products is likely to be mightily influenced by its previous work experience dictated by the rules of the internal market. Clearly also, the adaptability and employability of those exited to the exterior labor market is materially influenced by these internal experiences and training.

Microeconomics has recently turned its formal analysis to pensions, to incentives for the work force, to productivity, and other features of internal labor markets. But efficiency is not the only test that a society applies to its labor markets, and particularly to internal markets, which are asked to meet tests of equity, security, equal employment opportunity, and other goals. In brief, I do not believe that microeconomic theory is adequate to provide a useful understanding of internal labor markets and their effects on internal and external movements of labor, on internal wage structures for job classifications in enterprises of size, and for on-the-job training. These are vast areas of labor market experience and wage determination that need to be incorporated in a consolidated industrial relations and economic perspective.

2. Persistent differentials from product market and establishment size. It is a well established fact th at wage rates or average hourly earnings for a defined job classification, such as maintenance electrician or keypunch operator, show very wide variations in a locality, particularly in a community with a variety of industries. The top wage rates for a job classification are often two or three times the low ones. Differences in fringe benefit programs normally expand on these differences.

Neoclassical economics has sought to live with these large differences by proposing that they are related to the quality of the labor force in the different enterprises; compensating differences in working conditions, safety, distances, and the like; differences in information; and by the fact that there are longer run competitive forces in labor markets tending to eliminate these differences. Experience teaches that this view of wage rate differentials is simply grossly inadeauate to the reality. Granted that some persistent differentials arise from the sources stressed by microeconomics, these are virtually impossible to measure satisfactorily. I regard it necessary to explain, in other than conventional microeconomic terms, the large wage rate and fringe benefit differentials that persist for a given job classification in a locality.

There are at least two sets of persistent and pervasive differentials, somewhat interrelated, that need to be recognized and explained. These differentials are not uniquely the result of collective bargaining, although the differentials may be more formally maintained under collective bargaining. The differentials are related to product market groupings of firms and; within a given product grouping, to the size of the establishment, or in some circumstances to the size of the enterprise. Different competitive conditions in product markets are related to different compensation levels for the job classification in the local labor market.

Economists have deep trouble with the concept of product market differences affecting wages because it appears that enterprises that are assumed to maximize profits are paying unnecessarily high wage rates for the amount and grade of labor required. The analytical soul is redeemed for some economists by explaining that the enterprise is sharing its rents with its employees. The view, derived particularly from business schools and public policy programs, that managers in large enterprises are concerned basically with balancing conflicting constituency interests, rather than simply with maximizing profits, leads to a similar relaxed view as to persistent wage and benefit differentials. Thus, the model of the enterprise is also at stake in the concern with persistent wage differentials.

Forty years ago, I argued that "labor markets do not resemble bourses, auctions, nor lcosed-bid arrangements." The institutional form of any market influences its performance. It is strange, indeed, that so many contemporary economists have come so late to the simple truth that a labor market is not well depicted as a bourse. In 1980, Robert E. Hall concluded that, "There is no point any longer in pretending that the labor market is an auction market cleared by the observed average hourly wage." Indeed, there never was any point in so pretending, and industrial relations and its practitioners never did.

3. Bargaining theory. It is imperative, in my view, to approach wage rate determination equipped with the tools of negotiation and dispute resolution. Bargaining has always been a problem in microeconomics because of the fewness of buyers and sellers, or because of an indeterminancy of results of negotiations, or because of the discipline's abhorrence of strikes, lockouts, and serious conflict, or because of the consequences of public intervention on market performance.

A number of efforts have been made to reconcile market wage and price determination with bargaining theory. But I do not believe these efforts are regarded as generally useful or satisfactory. There are several assumptions requisite to economic rigor which seem to me to render the theoretical frameworks rather unacceptable in wage rate determination; in my experience, there are typically scores of rules under discussion which are not readily transmuted into money on a fixed basis, and none of the parties to the negotiations is a monolith.

The essence of negotiations and mediation is the shifting alignments within each party. Between two parties, it takes three agreements, one within each side, to reach the third agreement across the bargaining table. This essential view of negotiations is repugnant to microeconomics. Outcomes in negotiations are variable, not prescribed by markets, and the institutional features of the markets do make a difference. Indeed, these institutional features are themselves subject to negotiated change.

IN SUM, an understanding and an adequate explanation of the behavior of labor markets and of wage determination inherently needs to integrate the contributions of economic analysis--and its dedictation to competitive markets--and those of industrial relations with its acceptance of internal markets, persistent differentials in compensation generated by product market differences, and the negotiation process. Serious error and bias are derived from trying to get along with one without the other. Such integration is in keeping with the long-run mainstream of economics. To facilitate this integration, and thus the discourse on labor markets and wage determination, is one of the major intellectual responsibilities of the Industrial Relations Research Association.

I fully recognize that the integration of industrial relations and microeconomics is likely to involve for economics a loss of formal rigor and intellectual beauty. But abstration and relevance were never so far apart in economics. A sensitivity to industrial relations remains essential to an understanding of and sensible policy prescriptions for labor markets and wage determination.
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Title Annotation:adapted from paper presented at 37th Annual Meeting of Industrial Relations Research Association, Dallas, Texas, December 1984
Author:Dunlop, John T.
Publication:Monthly Labor Review
Date:Jul 1, 1985
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