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Labour market theories in contemporary economics

Article in Transformations in Business and Economics · January 2011

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 LABOR MARKET THEORIES IN CONTEMPORARY ECONOMICS

Prof. Wacław Jarmołowicz, PhD

Prof. at the PUE
Department of Macroeconomics and National Economy Research
Poznań University of Economics
Al. Niepodległości 10
61-875 Poznań
Tel. +48618543016
Fax.: +48618543034
e-mail: wacł[email protected]

Magdalena Knapińska, PhD

Assistant Professor at the PUE
Department of Macroeconomics and National Economy Research
Poznań University of Economics
Al. Niepodległości 10
61-875 Poznań
Tel. +48618543629
Fax.: +48618543034
e-mail: [email protected]

Wacław Jarmołowicz – he specializes in the theory of economics (mainly regarding

macroeconomy) and in the economic policy (especially regarding labor management). He is
an author and co-author of around 250 scientific and educational publications, as well as over
a dozen of scientific monographs. Moreover, he is a co-author (together with M. Knapińska)
of the scientific monograph titled ‘Polityka państwa na rynku pracy w warunkach
transformacji i integracji gospodarczej’ (State Policy on Labor Markets under the Conditions
of Transformation and Economic Integration), Wydawnictwo Akademii Ekonomicznej in
Poznań, Poznań 2005. Also known for his social activities in the Polish Economic Society, he
is a member of the Poznań Society of Friends of Science. He has developed vast contacts with
the practical economy world as a consultant, mediator and expert for companies and
institutions, including those of the state and local authorities.

Magdalena Knapińska - she is a co-author (with W. Jarmołowicz) of the scientific

monograph titled ‘Polityka państwa na rynku pracy w warunkach transformacji i integracji
gospodarczej’ (State Policy on Labor Markets under the Conditions of Tranformation and
Economic Integration), Wydawnictwo Akademii Ekonomicznej in Poznań, Poznań 2005. In
her scientific research she concentrates mainly on the issues related to the functioning of the
labor market and wages and on the labor market policy both in Poland and in Europe. She is
an author and co-author of over ninety scientific articles on the above mentioned topics.
Abstract

The subject of this article is a synthetic presentation, analysis and evaluation of contemporary
labor market theories, especially based on the achievements of the authors of the neo-classical
and Keynesian schools. First, there is presented the genesis and main concepts of the
traditional views and then the newest theories of the main stream of economy referring to the
functioning of the labor market in developed countries are presented. Special attention is paid
to the issue of work force mobility and flows. The review of chosen contemporary labor
market theories has been conducted in three areas. The first one emphasizes mainly the
structural and institutional factors as the ones causing unbalance on the labor market, which is
exemplified by the segmentation theory. In the second one it is stressed that unbalance may be
caused by interferences in long-term adjustment processes on the labor market, and which is
presented in the human capital theory, natural rate of unemployment theory or the job search
theory. The third area of discussion concerns the idea that unbalance on the labor market may
result from the inflexibility of wage, which has been assumed in the efficient wage theory and
in the insider-outsider theory.

Key words: labor market, labor market theories, theory of economics

JEL CLASIFICATION: J40

Summary

The subject of this article is a synthetic presentation, analysis and evaluation of contemporary
labor market theories, especially based on the achievements of the authors of the neo-classical
and Keynesian schools. First, there is presented the genesis and main concepts of the
traditional views and then the newest theories of the main stream of economy referring to the
functioning of the labor market in developed countries are presented. Special attention is paid
to the issue of work force mobility and flows. The review of chosen contemporary labor
market theories has been conducted in three areas. The first one emphasizes mainly the
structural and institutional factors as the ones causing unbalance on the labor market, which is
exemplified by the segmentation theory. In the second one it is stressed that unbalance may be
caused by interferences in long-term adjustment processes on the labor market, and which is
presented in the human capital theory, natural rate of unemployment theory or the job search
theory. The third area of discussion concerns the idea that unbalance on the labor market may
result from the inflexibility of wage, which has been assumed in the efficient wage theory and
in the insider-outsider theory.
1.1 Neoclassical and Keynesian views on labor market functioning

In the economic literature, both regarding the traditional and modern approaches,
particular attention is paid to the formation of labor market balance and formation of general
balance in the economy. Therefore it is worth analyzing at least some of the employment and
labor market theories, especially those which emphasize the problems of workforce mobility
and flows of employees. The theories presented and analyzed in the article are mainly situated
in the main stream of economic theory and its two major directions: neoclassical and
Keynesian.
Neoclassical employment theories refer to the model of perfect competition on the
labor market, developed by A.C. Pigou, which is based on certain assumptions. Firstly,
employers and employees have almost full information on wages and employment
possibilities available on the market, thus the labor market is thoroughly transparent.
Secondly, both employers and employees are ‘rational’ in the economic sense: employers
strive at maximum profit and employers aim at maximum satisfaction of real wages. Thirdly,
every employer and employee represents such a small portion of the overall labor demand that
their individual decisions have no influence on wages. Fourthly, there are no obstacles to the
labor force mobility and other production factors. Fifthly, employers and employees act
individually, without agreement with other employees or employers, while making pay or
employment decisions. Sixthly, labor on particular markets is uniform and changeable
(movable in the economic sense) (Kryńska 2000, p. 16).
According to the neoclassical concept the balance on the labor market does not
exclude occurrence of unemployment. This phenomenon is defined as a result of limitations
to the freely functioning of the pay mechanism, thus being a consequence of collision of
employees’ actions with free market requirements. Therefore unemployment is treated here as
a voluntary phenomenon related to the emerging unbalance on the labor market (Kwiatkowski
2009, p. 11).
As for the unemployment causes A. Marshall mentioned such factors as changing
demand for goods, insufficient ‘human capital’, economic condition fluctuations. Moreover,
he emphasized that this phenomenon was temporary and voluntary, meaning that employees
both accepted functioning of their trade unions and being represented by them. As a
consequence they also had to accept the possibility of being unemployed (Jarmołowicz,
Szarzec, 2008, p. 17).
It should be noticed that the economic tradition has used the information asymmetry
only to a little extent. It has been usually assumed that the labor market is transparent and
work places and employees are homogenous (Jarmołowicz, Knapińska 2005, p. 45). As a
result job offers for employees are identical regarding wages and as for employers all
employed persons are characterized by the same work efficiency. The proponents of the
neoclassical theory paid special attention to the assumption that wages were perfectly flexible,
which meant they reacted fast to the changing relationship between labor supply and demand
on the labor market (Wojciechowska 2005, p. 95).
Even in compliance with the classical economics approach, A. Smith suggested that
imperfections in functioning of market mechanisms were the source of migration. These
imperfections resulted in excessive labor demand and relatively high wages on some markets
while on others labor supply was too high and the wages were relatively low. The differences
between wages on theses markets led to the movement of labor force which resulted in
adjustment of pay rates and establishment of balance on both markets (Roszkowska 2009, pp.
160-161).
Thus the proponents of classical and neoclassical employment theories related
occurrence of employment (mainly the structural one) also with insufficient mobility of labor
force. According to their arguments, if unemployment appeared on a labor market it was
caused by the fact that there was practically no free movement of labor force among
professions or areas of economy. The actual influence of reduced mobility of labor force
between labor market sectors on the rate of wages was, therefore, much less significant than
expected and the processes of wages determination and labor force mobility were not so
closely connected with each other (Kryńska 2000, p. 17). Practically, the movement of
employees among professions was much interfered by the necessity of having various
qualifications and skills, which were indispensable for performing a given job. Moreover,
movement among geographic regions was limited by costs or traditions, which constituted
barriers for changing one’s workplace. Finally, changing the area of one’s profession required
professional training and other predispositions, just as it was in the case of changing a
performed job. Therefore, there were remarkable differences between the functioning of the
labor market under the condition of perfect competition, as defined by neoclassicists, and the
actual functioning of the labor market.
Thus, taking into account implications of the neoclassical model, if employment
problems emerged the employees were capable of accepting lower wages, even down to the
level at which demand equaled supply. Such assumption, however, was questioned by J. M.
Keynes, who argued that labor was highly inflexible and that wages were characterized by a
kind of inflexibility (especially regarding their downward movement) which might lead to the
occurrence of balance in economy, even if employment was not full. Such a situation would
be caused not only by interference in wages adjustment but also, and even the most
significantly, the lack of global demand (Woźniak 2008, p. 32).
Moreover, according to J.M. Keynes, lowering of nominal wages decreased
transaction demand for money, which meant, while the nominal supply of money remained
the same, bigger supply of money for speculative purposes. In this situation the interest rate
could drop, which was a stimulus to investments and thus leading to a multiplier growth of
production and employment. The writer perceived this mechanism of lowering nominal wages
influencing the growth of employment, however, he treated it as highly uncertain, while
emphasizing two weaknesses of such reasoning. Firstly, lowering of nominal wages did not
have to result in the drop of interest rate. Secondly, even if it was possible to lower the
interest rate, it was not certain if investments would increase as the capital efficiency might
decrease even more. Therefore J. M. Keynes concluded that lowering of nominal wages did
not guarantee full employment (Kwiatkowski 2002, pp. 111-112).
In his objection to ‘cutting down’ on nominal wages, J.M. Keynes went even further,
reaching beyond only practical issues. He rejected the postulate of wages and prices flexibility
as an efficient method for restoring balance, also with reference to theoretical premises
(Snowdon, Vane, Wynarczyk 1998, p. 81).
Moreover, J.M. Keynes claimed that the supply unbalance on the labor market was
already the compulsory unemployment, as it was impossible for unemployed persons to
change their situation and avoid being unemployed. Neither requalification nor higher
mobility, nor even accepting lower rate of wages, would change the position of an
unemployed person. The only actual solution to that situation could be an action of the state
aiming to fight unemployment (Jarmołowicz, Szarzec 2008, p. 21).
Generally speaking, it must be stated that J. M. Keynes did not share the opinions of
neoclassicists on the efficiency of market mechanisms in the market economy. He also
believed that under the conditions of free functioning of the market mechanism a tendency
emerged to establish a surplus of labor force supply over the labor demand, which meant the
existence of unemployment. He thought the insufficient demand for goods was the reason of
this tendency (Wąsowicz 2007, p. 44).
1.2 Contemporary labor market theories

Nowadays there are numerous alternative economic theories regarding labor market
functioning. However, these theories basically modify and develop the achievements of
neoclassical and Keynesian approaches, often including varying or expanded and
supplemented sets of hypotheses related to the occurrence, emergence and maintenance of
unbalance on the labor market. All in all, there could be defined three basic groups of
alternative hypotheses. Those of the first area emphasize mainly structural and institutional
factors as the ones responsible for the emergence of unbalance on the labor market.
Segmentation, in which the issue of labor force mobility limitation constitutes a crucial
element explaining the processes of creation and establishment of unbalance on the labor
market, is an example of such theories. (Kryńska 2000, p. 18).
According to the assumptions and premises characteristic of the second area,
unbalance may be caused by long-lasting (delayed) processes of adjustment to the labor
market (e.g. due to searching for jogs, changing qualifications, etc.). This area includes the
theory of human capital, natural rate of unemployment theory as well as the job search theory.
All these theories emphasize relationship between restrictions to employees’ mobility
(especially the professional one) and unbalance on the labor market (Kryńska 2000, p. 18).
In the third group of hypotheses it is assumed that the labor market unbalance may be
caused by the inflexibility of wages. It is explained in such theories as the efficient work
theory and insider-outsider theory. The theories focus on explanation of reasons and
conditions for some employers to offer wages exceeding the balance wage. However, the
issue of labor force mobility is given here relatively little consideration. It is rather pointed
out that the directions and intensity of movements of employees result from pay decisions of
employers - the higher wages are the lower tendency to move. Thus, in this perspective, the
employees’ mobility is a derivative of the structure of wages on a particular labor market
(Kryńska 2000, p. 18).
While attempting to analyze and estimate the segmentation theories presented in the
literature, it should be noticed that labor market segmentation concepts assume the
differentiation of the labor market (its heterogeneity). This differentiation of supply and
demand regarding work and all related phenomena allows for determination of such parts of
the market which are characterized by relative homogeneity. Although the notion of labor
market segmentation has not been defined unequivocally in the literature, it is relatively easy
to determine numerous common characteristics both of the segmentation process as well as of
the resulting market sectors. According to E. Kryńska the idea of limited access to some
sectors or separation of particular labor market parts, between which labor force mobility is
limited, are examples of such features. The limitation of labor force access to these sectors
may be caused by particular requirements of heterogeneous work places, which expressly
eliminate some categories of employees (Kryńska 2000, p. 19).
Therefore at least two key elements of segmentation theories may be defined. Firstly,
the labor market consists of several levels which are characterized by different conditions
offered to employees regarding their wages and employment policy. Secondly, entering such
levels (labor market sectors) is limited, at least in some periods of time, i.e. there are more
persons willing to work in those sectors than workplaces offered by employers (Dickens,
Lang 1992).
These particularly important segmentation theories include the dual labor market
theory and the internal-external labor market theory. The former one, formulated by P.
Doeringer and M. Piore, claims that the labor market is divided into two parts in which
employees and employers act following totally different principles of behavior and which are
characterized by various features. The labor market is perceived as a uniform area but also as
a multitude of markets of different structures and features (Kryńska, Suchecka, Suchecki
1998, p. 33).
These two sectors are in the literature referred to as the ‘primary’ and ‘secondary’
sectors. The primary sectors covers stable well paid workplaces characterized also by
promotion possibilities, however the secondary sector consists of work places of lower
prestige, worse paid, the number of which in an economy varies depending on the fluctuations
of the economic situation (Wąsowicz 2007, p. 56).
Free access to work places on the primary market is limited by precisely defined
employment criteria, precisely defined professional career ladder and finally by the
procedures of periodical assessment of workers and their dismissing. The aim of the selection
applied while employees enter the primary sector is to avoid hiring persons who are not
capable of performing their tasks in the way imposed on them by the requirements of this
sector (Kryńska 2000, p. 22).
On the other hand unattractiveness of work places in the secondary sector results in
high fluctuation of employees and ease of changing jobs. The secondary sector is dominated
by immigrants, juvenile workers, some women and others, who have been pushed to it
(Kryńska 2000, p. 22).
The issue of differences between the labor market sectors is discussed in the literature.
The first difference is the amount of wage, which depends on qualifications or professional
experience. It appears that the primary labor market is characterized by higher wages and the
secondary one by lower ones. Moreover, it is often noticed that other problems play here an
important role, such as racial, sexual or national discrimination. However, the research
showed that, as W.T. Dickens and K. Lang wrote, wages kept growing faster together with
growing qualifications in the group of the dark skin workers than among the white skin
workers (Dickens, Lang 1992, p. 9). Moreover, and which is very interesting, another research
showed that dark skin workers who started their professional careers on the secondary labor
market were less eager to move to the primary labor market than white skin workers (being in
a similar situation). Thus the problem of occurrence of a dual labor market, at least in the
American context and from the perspective of the research regarding racial segmentation, was
actually found and this theory should be regarded as one being proven empirically or
positively verified.
According to W. Janicki the dual labor market theory explains the reasons for external
migrations using also macroeconomic factors. It assumes a permanent lack of employees in
highly developed countries for a number of jobs which, due to prestige issues, are not
performed by the citizens of these countries. They include dangerous jobs with hard work
conditions, low paid jobs and jobs requiring little qualification. It is this sector of the market
that is the target for immigrants (Janicki 2007, p. 290).
Another representative segmentation theory called the internal-external labor market
theory assumes that the labor market consists in fact of internal and external labor markets.
The researchers using these categories tend to define only the former one. The external labor
market refers to the areas which are not covered by the internal market, thus constituting the
rest existing everywhere the internal market has not developed. However, the internal labor
market is defined by employment entities (e.g. enterprises) in which wages and labor force
allocation are regulated by constant norms and procedures. These are organization units in
which such functions of the market as establishment of labor price, its allocation and trainings
are realized using defined institutional principles. These principles also determine criteria for
joining internal markets, privileges of persons employed there and relations between
particular jobs necessary for the internal mobility of employees (Kryńska 2000, p. 24).
Moreover, a concept of traditional static division of particular labor market parts
appeared in the literature. Thus the labor market may be divided taking into account various
criteria: professional, demographic and spatial. These sectors may function more or less
independently of each other thanks to the heterogeneous nature of labor supply and demand.
Geographic space is another category differentiating labor markets which is used for
determining local and regional labor markets. Labor force mobility among them is rather low
and it is restricted by high costs of movement. The geographical space acts as a mobility
barrier and is the reason why the adjustment processes related to it (migrations, commuting to
work) are not flexible enough to ensure efficient adjustment of supply and demand on the
nationwide labor market (Kryńska, Suchecka, Suchecki 1998, p. 38).
Furthermore, as regards theories indicating significant adjustment delays emerging on
labor markets, the human capital theory is worth presenting. This theory was formulated in
the early 60’s in the USA. The year 1962 was a crucial year for the development of this theory
when a special issue of the „Journal of Political Economy” appeared containing the initial
chapters of the monograph by G.S. Becker titled Human Capital (Becker 1990). The main
representatives of the human capital theory are, except for G.S. Becker, T.W. Schultz and T.
Mincer (Kucharski 2001, p. 41). A particular role for the creation of this theory is credited to
G.S. Becker, who believed that wage difference was caused by differentiated equipment in
human capital of particular employees, regarding their education, professional qualifications
skills and professional experience. They are acquired by the way of individual decisions
regarding investing in one’s own labor potential.
The human capital theory introduced a dichotomic division of labor force
qualifications into the universal and specific ones. Employees possessing universal
qualifications were most often offered posts which did not require long trainings and were
related with doing simple actions. However, if workers had specific qualifications they were
given more prestigious positions which were better paid and characterized with lower
fluctuation of change at the work place (Wąsowicz 2007, p. 55-56). Thus we can observe here
certain influence of one’s qualifications on labor resources mobility. Employees with
universal qualifications may be more willing to change their work place while those who have
specific qualifications will rather ‘stick’ closely to their workplaces, sometimes even
irrespective of the level of the pay they would receive.
Another recognized theory in the stream emphasizing occurrence of significant delays
in adjustments on labor markets is the natural rate of unemployment theory also called the
balance unemployment theory. It was developed by M. Friedman and E.S. Phelps, although,
as it is commonly known, other scientists also played here an important role. First of all and
regarding the genesis of this theory, the statistical and economic analyses of A.W. Phillips
should be mentioned. He concluded that there was a negative relationship between the rate of
nominal wages growth and the unemployment rate (Jarmołowicz 2010b, p. 141). R.G. Lipsey
also made an attempt to justify this relationship more closely and theoretically while using
two theoretical constructions. Firstly, he related the rate of the nominal wages change to the
situation on the market, which was defined by a relative surplus of labor demand over labor
supply. Secondly, for Lipsey the rate of the relative surplus of labor demand over labor supply
was related with the unemployment rate (Kwiatkowski 2002, pp. 140-141).
Taking the above relationships into consideration, it may also be stated that there is
such a level of unemployment (i.e. a surplus of labor demand over labor supply) which
stabilizes nominal wages, and which is of crucial importance or the unemployment rate.
However, it was M. Friedman who formulated the most elaborate definition of the natural
unemployment rate, claiming that it was such a level that would result from the Walras
equations of the general balance, providing it took into consideration actual structural features
of labor markets and goods, market imperfections, stochastic changeability of demand and
supply, costs of collecting information on available work places and free labor force, costs of
labor force mobility, etc. (Friedman 1975, p. 271). Moreover, the natural unemployment rate
should be regarded as a certain level of frictional and structural unemployment which might
not be avoided as it resulted from the labor market imperfections and which was far from
perfect competition.
According to the theory of the natural unemployment rate the unemployment rate
would equal zero if the market functioned according to the assumptions of the perfect
competition. Natural unemployment exists mainly because there is no precise information on
available work places and free human resources. At the same time the labor itself is little
mobile and the competition between employers and employees is limited (Kryńska 2000, p.
37). In other words it is not the free market mechanisms which constitute the main cause of
unemployment but the limitations and imperfections of their functioning. Therefore the
natural unemployment rate theory may be considered in the group of theories emphasizing
delays in adjustment processes (Jarmołowicz 2010, p. 129).
Still another theory belonging to the trend of theories related to ‘certain delays’ is
called the job search theory. It is a microeconomic supplement of discussions conducted by
E.S. Phelps and M. Friedman under the natural unemployment rate theory. It also belongs to
the trend of the so-called new microeconomics, in which one of the basic assumptions of the
perfect competition on the labor market, i.e. the criterion of full access to information for both
transaction parties, has been abandoned. As a result the labor market has become non-
transparent. In this situation both employers and employees do not have thorough knowledge
about the conditions (particularly about wages) in other companies and regions. At the same
time, in order to make the right decision regarding their professional career, employees need
the fullest possible information on wages in the biggest possible number of companies as well
as they need to consider possible benefits stemming from the relationships between wages in
enterprises in closer and more distant environment (in the geographical sense). In order to
make their decision rational and possibly most profitable, they must devote much time to
searching for a job. There can always be found such employees who prefer to remain
temporarily unemployed in order to look for better job possibilities (Kryńska 1998, pp. 44-
45).
Within the search theories on the labor market much place has been specially devoted
to the determination of relationships between microeconomic theory of behavior of
individuals looking for jobs and offering jobs (together with the accompanying mobility
processes) and microeconomic relationships between inflation and unemployment (described
by the Phillips curve). Efficiency of the process consisting in both looking for jobs and
employees has become the most important issue. In both areas the search process efficiency
increases together with the size of the labor market. The relationship between the costs of
obtaining information and prospective profits is the better the bigger the labor market is. In
other words, the more partial labor markets (sectors) exist and the fewer benefits from the
search process are the less efficient the very search process is, and, consequently, the higher
level of unemployment is (so-called ‘search unemployment’) or (and) the fewer available
workplaces (Kryńska 1998, p. 46-47) .
This theory leads to particular conclusions regarding determinants of labor force
workflows. Firstly, the need to look for a better paid job may induce some part of the
currently employed to resign their posts and becoming unemployed. Searching for work is
more efficient and cheaper if a particular individual remain in the unemployment resources.
Secondly, the probability of outflow from unemployment or professional inactivity to
employment depends on the number of searches by unemployed or professionally inactive
persons. Thirdly, the probability of movement from unemployment to employment is to a
large extent influenced by the level of the reservation wage (i.e. the rate at which the
unemployed want to quit further searching and take up jobs). The higher the reservation wage
the lower the probability for an individual to move from unemployment to employment.
Fourthly, attention should be paid to the fact that the longer the unemployment period lasts
the more the intensity of job search decreases. Thus the possibility of outflow to employment
decreases, too. Prolonging the unemployment period may cause increasing outflow from
unemployment to the resources of professionally inactive persons (Kucharski 2001, p. 56-67).
According to many authors there are two types of search theories: the reservation
wage theory and the sample population theory. The first one analyzes the situation in which
expectations of persons looking for work focus only on the level of wages and not on the
number of job offers. It is assumed in both theories that the person searching for a job has
certain knowledge on distribution of wage offers in a particular group of qualifications, on the
local market, does not know which enterprise offers particular wage rates. The search process
begins with the establishment of the minimum wage level, also called the reservation wage,
below which the unemployed does not take up employment. This wage constitutes a limit of
profitability for further searches, i.e. it means equaling incurred costs with expected profits
(wage) (Wojciechowska 2005, pp. 104-105).
Another alternative way of searching for work is described by the sample size model,
which is based on the assumption that an unemployed individual, while searching for a job,
follows the principle of choosing the most profitable offer from the pre-determined number of
offers corresponding to his preferences. This model was developed in the early 90’s of the
20th century by C. Joll, C. McKenn, R. McNabb, J. Storey (Wojciechowska 2005, p. 110). It
assumes that job offers differ mainly by the level of wages and the unemployed of similar
qualifications already know their distribution. They do not know, however, which companies
reported demand for work. The search process aims at finding a group of employers who offer
jogs equally profitable and matching the expectations of the unemployed. Reaching a
particular group of companies is related with incurring costs: the bigger a researched sample
is the higher the costs (Wojciechowska 2005, p. 110). In this model it is assumed in particular
that before starting a search en employee makes a decision about checking n randomly chosen
companies on the market, and accepts this employer’s offer who offers him the highest wages
(Bludnik 2010, p. 37).
Another group of theories shows that unbalance on the labor market is caused by wage
inflexibility (Jarmołowicz 2010a, p. 131). This trend includes the efficient work theory, also
called in the Polish literature the motivating job theory, efficiency shaping wages theory,
theory of work versus efficiency (Kryńska 1998, p. 45), and also the pro-efficient wage theory
(Wojtyna 2000, p. 225). According to this concept enterprises define fixed wages at levels
higher than the wages balancing the market. It is assumed that the fact of being employed
does not guarantee that the employee should work well and efficiently. Therefore the
employer, in order to raise this efficiency, is eager to offer higher wage then the market wage
(Woźniak 2008, p. 35).
However, according to A. Wojtyna, in the contemporary economic thought there can
be determined four main concepts explaining creation of motivating wages which emerged in
the 80’s of the twentieth century (Wojtyna 2000, pp. 226-232, and also: Wojciechowska 2005,
pp. 112-120; Woźniak 2008, p. 36). The first of them is called the model of ‘idling’ or ‘idling
at work” and it was formulated by C. Shapiro and J.E. Stiglitz – it argues that wages defined
at the levels much higher than the labor market balance wages are an instrument to discipline
employees (Shapiro, Stiglitz, 1984, pp. 433-444). If employees limit their effort to the
minimum level then their usefulness equals the received wages, although, if they are caught
doing it, then their usefulness will decrease to the size of unemployment benefit. The threat of
being fired is a motivating factor, however acting not very efficiently if the employees may
find employment much more easily (Wojtyna 2000, p. 227).
The second concept related with the efficient work theory is the model of the staff
fluctuation rate, introduced to the literature by S. Salop (Salop 1979) and J.E. Stiglitz (Stiglitz
1985), according to which maintaining wage over the balance level may be profitable
regarding high costs related with the exchange of employment. Raising wages, however, is
profitable up to the point at which savings (regarding rotation) equal additional costs resulting
from higher wages.
The third approach within this concept is the model of the negative selection,
developed by A. Weiss (Weiss 1990), which presumes that employees can be better and
worse and that companies want to employ only the better ones while paying them higher
wages. It is also assumed that workforce is not homogenous. Thus selecting workers at the
recruitment process is one of the important functions of the wage; the wages exceeding the
market balance level allow to obtain better employees. Thus, by offering higher wages, a
negative selection of employees characterized by low efficiency is performed (Woźniak 2008,
p. 36). However, if a candidate is willing to take a job at a lower wage for the company it is a
signal that he or she does not have the expected qualifications. Simultaneously the reaction to
the unfavorable shock consisting in lowering the wage to the market level would constitute a
threat of the best employees resigning their positions (as it is the easiest for them to find new
jobs). However, if the adjustment is only of quantitative nature (meaning dismissions) then
the ‘quality’ of dismissed employees will depend on the decisions of managers (Wojtyna
2000, p. 229).
Finally the fourth way of explaining the occurrence of motivating wage constitute
sociological concepts, which include the gift exchange model developed by A. Akerlof
(Akerlof 1982, p. 543-569) and the fair wage model by G.A. Akerlof and J.L. Yellen
(Akerlof, Yellen 1990, p. 255-283). According to these theories employees work more
efficiently and show higher commitment if they are given wages higher than the average
wages characteristic of the particular kind of work and if they feel that the remuneration for
their work is fair. According to G.A. Akerlof, as E. Kwiatkowski states, an enterprise receives
a ‘gift’ from its employees in the form of commitment exceeding the minimum standards
whereas the employees receive a ‘gift’ in the form of higher wages (Kwiatkowski 2002, p.
193).
In the model of ‘a fair wage for fair work’ it is assumed that if employees feel they are
treated in an unfair way they lower their effort and commitment to work but if the wages they
receive are higher than the wages in a similar group of workers they feel motivated to bigger
effort. The tendencies to maintain relatively high wages result from the fears that once they
have been lowered the commitment and productivity of employees would drop, too
(Kwiatkowski 2002, pp. 193-194). In this model employees maximize the function of
usefulness, in which he key role is played by the relationship between the received wage and
the wage perceived as fair and the level o unemployment. Similarly to other models, a surplus
of offered wage over the market balance wage will lead to the real wage stickiness and
compulsory unemployment (Wojtyna 2000, p. 230).
A different theory belonging to the stream of theories explaining unbalance on the
labor market through the inflexibility of wage is the theory of insiders-outsiders presented by
A. Lindbeck and D.J. Snower (Lindbeck, Snower 1988). The basic method allowing to
explain the issue consists in dividing the population of workforce into insiders and outsiders
(Kryńska 1998, p. 56-57). These categories correspond to groups of employees associated
with trade unions (insiders) and employees who are not associated or unemployed (outsiders).
This division is regarded as not sharp as the basic differentiating criterion is the ability of a
particular group to influence the outcome of pay negotiations (Wojtyna 1994, p. 4). The
position of insiders is relatively strong and is protected by the existence of remarkable costs of
adapting new employees to their work places, such as costs of searching, choosing and
training as well as costs of dismissing other workers. Thus outsiders may only influence
indirectly the risk of losing jobs and lowering wages by the insiders as they are separated
from direct competition by the barrier of the employer’s exchange costs (Kryńska 1998, p.
57).
As it was presented before, the idea of the natural unemployment rate as the balance
was proposed within the neoclassical trend in the economy, and it is still continued and
modified. This concept was also answered and appreciated on the ground of the Keynesian
trend, which was considered while being based on the inflexibility of wages. In the 80’s and
90’s of the 20th century a group of British economists (R. Jackman, R. Layard and S. Nickell)
proposed the NAIRU theory, in which the key role was played by the balance unemployment.
According to these authors when unemployment was relatively low inflation processes
increased whereas when unemployment was adequately high inflation processes decreased.
These authors came to the conclusion that there was such a level of unemployment which
stabilized the dynamics of inflation processes and it was called NAIRU unemployment and
was regarded as the balance unemployment (Kwiatkowski 2009, p. 14).
It should be noted here that the concepts of the natural unemployment rate and the
NAIRU rate are not identical and there are many differences between them. Although both
concepts refer to the notion of balance unemployment, the first one assumes flexibility of
prices and wages in a short period of time and adapts many further assumptions of the
neoclassical trend (perfect competition, recommendations to apply instruments of the
monetary policy in order to shape the actual unemployment rate outside the balance state).
However, the NAIRU idea assumes inflexibility of prices and wages and other neo-Keynesian
premises (imperfect competition, recommendations to apply economic policy influencing the
overall demand) (Woźniak-Jęchorek 2009, p. 42-45).
Summing up, the theoretical concepts presented before and regarding functioning of
contemporary labor markets in market economy, and referring also to the issue of workforce
mobility and flows, may be pictured in the form of a diagram shown in Figure 1 below.

Contemporary labor market theories

Segmentation theories Theories based on delays in Theories based on wage

adjustments to labor market inflexibility

Dual labor market Human capital theory Efficient work

theory theory

Internal and external Natural Insider-outsider

labor market theory unemployment rate theory
theory

Traditional divisions Labor market search NAIRU theory

of labor market theory
sectors

Figure 1. Labor market theories from contemporary perspective

Source: Own study based on (Kryńska 2000, p. 18).
1.3 Summary
The labor market theories presented and analyzed in the article indicate that there are
rational premises which are taken into account by employees while they make decisions about
changing their workplaces, about searching for better paid jobs and decisions about other
issues related with performing jobs. These theories focus both on micro- as well as macro-
economic circumstances and ways of functioning of the labor market in the contemporary
market economy. The labor market theories explain some causes of mobility (spatial, social
and professional) and flows of workforce.
Simultaneously it may be noticed that contemporary labor market theories, being
rooted in the achievements and traditions of neoclassical and Keynesian views, constitute
their creative development which is much closer to the contemporary reality.

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