External Labor Market

Labor markets provide a mechanism for employers and employees to agree on terms for exchanging labor input for wages. In accepting an employment relationship, a worker agrees to receive wages (and other inducements) in exchange for submitting to the directives of the employing organization within some zone of indifference. On the labor supply side, individuals adjust their hours of work in the labor force on the basis of changes in income, career opportunities, and other conditions of employment. On the demand side, employers adjust their engagement of labor on the basis of changes in relative prices of labor, the quality of labor, and other constraints. For labor markets to operate efficiently and effectively, mechanisms must be in place to support flexibility and adaptability to changing levels of supply and demand, while conforming to social expectations regarding equity, morality, and so forth.

Labor markets exist within the firm and external to the firm. Internal labor markets are characterized by job ladders in the firm, supported by evaluation systems that reward skill development and worker commitment. Entry to the firm occurs mostly at the bottom of the ladder, and movement up the ladder follows the development of skills. Internalized work often comes with the implicit understanding that employment is permanent, or at least long term. External labor markets, by contrast, are normally [Page 653]more flexible, unless they are tightly regulated by governments or constrained by the behavior of labor interest organizations. External market transactions consist of contractual relationships that specify what each party to the exchange is to deliver. The simplest form of employment contract is the spot contract in which all obligations are fulfilled on the spot, as in the case of hiring day labor without any obligations for the future. To the extent that internal labor markets produce employment stability, internalization makes it expensive and politically difficult to adjust the volume of labor to changing internal organizational and external market conditions. This is the main reason why firms typically externalize labor—draw on external labor markets—when they recruit workers.

Under normal conditions, internalization increases the employer's organizational control over employees, whereas externalization enhances organizational flexibility. Externalization of labor is typically seen as a means to complement internalization and to circumvent some of the problems created by internal labor markets. In some Western countries, the external labor market is extremely dynamic, as in the United States where the proportion of new job-person matches over a five-year period has been estimated to be about 40 percent, with significant variations across age groups. General intercountry comparisons are not very revealing if they ignore differences in labor movement in terms of opportunity factors such as the size distribution of firms in a given industry and the degree of job growth over the business cycle.

Recent Developments

Recent decades have seen significant developments in labor markets in the international arena, as firms are trying to regain some of the competitiveness they have lost because of rising labor costs and the growing success of producers in newly industrializing nations. One strategy many firms use to contain labor costs is to introduce a variety of flexible working arrangements that are expected to improve the link between the level of output and the demand for labor. Some of these arrangements are based on using the external labor market as a source of employment flexibility. The most prominent of these arrangements include increased reliance on subcontracting and the increased use of temporary employment contracts. Both are considered forms of employment externalization. Externalization through the use of temporary workers has the effect of reducing the duration of employed labor in the firm, whereas externalization through subcontracting activities to independent workers is a means of increasing flexibility by reducing administrative control over labor.

...