INTRODUCTION TO LABOUR ECONOMICS amp PERSONNEL ECONOMICS

12

Labour economics can be simply defined as the economic analysis of labour market where as business dictionary1 illustrates lsquolabour marketrsquo as ldquo(usually) an informal market where workers find paying work employers find willing workers and where wage rates are determinedrdquo

Definition and coverage of Labor Economics

Labor economics encompasses many of the most important issues in economics Most people earn most of their income by selling their labor time So labor economics deals with the major source of personal income what determines it and why it may differ for different individuals It also deals with the allocation of the most important (in value terms) input into the production process

From a formal context Labor economics is the field of economics which examines the organization functioning and outcomes of labor markets the decisions of prospective and present labor market participants and the public policies which relate to the employment and payment of labor resources2

Labor economics as one of the major sub division of economics focuses its attention upon the economics aspects of the problems insecurities and institutional development associated with labor Labor economics involves analyzing the determinants of the various dimensions of labor supply and demand which interact to determine wages employment and unemployment

There are many dimensions to labor supply including demographics (the effects of birth and date rate) immigration and emigration policies (perhaps a brain drain) the labor force participation decision the hours of work decision (including overtime and moonlighting) education and training (human capital decisions) and the disincentive effects of income maintenance and unemployment insurance policies

Labor demand focuses on how firms vary their demand for labor in response to changes in the wage rate and other costs including fringe benefits legislatively imposed costs and the quasi-fixed costs associated with hiring and training workersSince labor demand is a derived demand (derived from the demand for the firms output) it is also influenced by factors such as free trade global competition and technological change

Labor market outcomes are also influenced by the type of market structure (the degree of competition) union collective bargaining and various government laws (such as minimum wage laws)

In recent time labor economics has become increasingly empirical with less emphasis on theory Among the areas growing or receiving the greatest attention are changes in the wage structures (including occupational industrial and regional wage differentials unionnon-union wage differentials and malefemale wage differentials the issue of sex discrimination in the labor market) the economics of education social interactions and

1 wwwbusinessdictionarycom2 Campbell R McConnell Stanley L Brue David MacPherson (2005) Contemporary Labor Economics

1

INTRODUCTION TO LABOUR ECONOMICS amp PERSONNEL ECONOMICS

12

personnel economics The range of topics studied by labor economists today has broadened far beyond those of traditional labor economics

An overview of Labor Economics

At first it is valuable to have a brief overview of our field of study The overview yields insights as to how the subject matter of various issues of labor market relate to each others The most aspects of labor economics can be fitted under the headings of lsquomicroeconomicsrsquo and lsquomacroeconomicsrsquo As we know microeconomics is concerned with the decisions of individual economic units and functioning of specific markets On the other hand macroeconomics is concerned with the economy as a whole or with basic aggregates which constitute the economy Hence the determination of wage rate and the level of employment in a particular market ndash carpenters in Sylhet or retail clerk in Dhaka- are clearly microeconomic matters In contrast the consideration of the average level of real wages the aggregate levels of employment and unemployment and the overall price level are issues of in macroeconomics But some of the subject matters sometimes pertain to both aspects of economics

Labor economics has both microeconomic and macroeconomic dimensions of analysis Microeconomics focuses upon the determinations of labor supply and demand and the ways in which supply and demand interact to determine wage rates and employment in various labor markets Labor unions government and discrimination all affect labor markets through either supply or demand Labor market determine the wage structure and the personal distribution of earnings

They also generate incentives for labor mobility and migration Macroeconomics stresses the aggregative aspects of labor markets and in particular labor productivity labor share of national income the overall level of employment and the impact of wage upon the price

2

INTRODUCTION TO LABOUR ECONOMICS amp PERSONNEL ECONOMICS

12

level The above diagram3 shows the relationship among various contents of labor economics

Distinction of labor and scope of labor economics

Labor possess some distinguishable characteristics than those of other goods or services

1048708 Labor services are rented not sold 1048708 Suppliers of labor care about the way in which the labor is used 1048708 Labor productivity is affected by pay and working conditions1048708 labor supply is affected by Non-monetary aspects (ie leisure time)

Distinction of Labor from other Goods and Services-

Aspect of Labor Explanations amp Examples Consequences1 Labor is a factor of production not a final product

Unlike most goods whichhouseholds buy labor is one of the few goods they sell

-income effects work in different ways for labor than other goods ldquoperverserdquoresponses like ldquobackward-bendingrdquo labor supply are more likely -the demand for labor is a derived demand from the demand firms face for their products

2 Like capital labor is a flow of services attachedto a stock of ldquoequipmentrdquo

The ldquostockrdquo in this case is the worker and the skills heshe possesses The ldquoflowrdquo is the right to use it for a period of time

-the stock must be produced and maintained education training are needed-in most cases delivery of the ldquoflowrdquo requires physical presence quality of the work environment matters

3 Unlike capital theldquostockrdquo cannot be bought and sold

-Slavery is prohibited-For various reasons people canrsquot sell ldquosharesrdquo inthemselves for example tofinance education

-borrowing constraints may matter for human capital investment (education)-human capital investment is riskier than physical capital investment because it is non-diversifiable

4 Labor is a veryheterogeneous commodity

-Workers are differentiated by type of skill amount of skill demographic characteristics

-a wide variety of prices and market conditions for different labor services can coexist This gives rise to a distribution of earnings

5 The quality of labor services being supplied is often hard to measure

-workers may simply ldquoshirkrdquo-poor management decisions may not be apparent for years

-compensation and incentive systemsneed to be designed appropriately

6 Sometimes thedemanders andorsuppliers of labor have considerable monopoly power

-employersrsquo associationscompany towns other monopsonists-unions-search costs relationship-specificskills and bilateral monopoly

-use monopolymonopsony and search theory to study these markets

7 Labor markets arehighly regulated the exchange of labor is bothhighly taxed and

-income and payroll taxes-income support programs-workplace safety legislation-immigration policy-industrial relations legislation

-government policy has important effects on labor markets

3Campbell R McConnell Stanley L Brue David MacPherson (2005) Contemporary Labor Economics

3

INTRODUCTION TO LABOUR ECONOMICS amp PERSONNEL ECONOMICS

12

level The above diagram3 shows the relationship among various contents of labor economics

Distinction of labor and scope of labor economics

Labor possess some distinguishable characteristics than those of other goods or services

1048708 Labor services are rented not sold 1048708 Suppliers of labor care about the way in which the labor is used 1048708 Labor productivity is affected by pay and working conditions1048708 labor supply is affected by Non-monetary aspects (ie leisure time)

Distinction of Labor from other Goods and Services-

Aspect of Labor Explanations amp Examples Consequences1 Labor is a factor of production not a final product

Unlike most goods whichhouseholds buy labor is one of the few goods they sell

-income effects work in different ways for labor than other goods ldquoperverserdquoresponses like ldquobackward-bendingrdquo labor supply are more likely -the demand for labor is a derived demand from the demand firms face for their products

2 Like capital labor is a flow of services attachedto a stock of ldquoequipmentrdquo

The ldquostockrdquo in this case is the worker and the skills heshe possesses The ldquoflowrdquo is the right to use it for a period of time

-the stock must be produced and maintained education training are needed-in most cases delivery of the ldquoflowrdquo requires physical presence quality of the work environment matters

3 Unlike capital theldquostockrdquo cannot be bought and sold

-Slavery is prohibited-For various reasons people canrsquot sell ldquosharesrdquo inthemselves for example tofinance education

-borrowing constraints may matter for human capital investment (education)-human capital investment is riskier than physical capital investment because it is non-diversifiable

4 Labor is a veryheterogeneous commodity

-Workers are differentiated by type of skill amount of skill demographic characteristics

-a wide variety of prices and market conditions for different labor services can coexist This gives rise to a distribution of earnings

5 The quality of labor services being supplied is often hard to measure

-workers may simply ldquoshirkrdquo-poor management decisions may not be apparent for years

-compensation and incentive systemsneed to be designed appropriately

6 Sometimes thedemanders andorsuppliers of labor have considerable monopoly power

-employersrsquo associationscompany towns other monopsonists-unions-search costs relationship-specificskills and bilateral monopoly

-use monopolymonopsony and search theory to study these markets

7 Labor markets arehighly regulated the exchange of labor is bothhighly taxed and

-income and payroll taxes-income support programs-workplace safety legislation-immigration policy-industrial relations legislation

-government policy has important effects on labor markets

3Campbell R McConnell Stanley L Brue David MacPherson (2005) Contemporary Labor Economics

3

INTRODUCTION TO LABOUR ECONOMICS amp PERSONNEL ECONOMICS

12

subsidized -affirmative action comparable worth

All these distinguishable characteristics of labor and enormous importance of labor market create the scope of accommodating the labor related economic discussion into a separate sub-discipline of economics ie labor economics

Importance of labor economics

Traditionally labor economics is linked to the central core of economics by the theories of labor market and wage determination Most of the grown up population allocate a substantial fraction of their time to the labor market The labor market is one of the most important mechanisms for transmitting the benefits of economic growth to different groups in society

We are studying the economics of the labor market but what exactly is ldquothe labor marketrdquo We can define it simply as all the buyers and sellers of labor services and the institutions those facilitate that buying and selling But what are labor services Labor services are the direct input of human muscle and brainpower into production Obviously this is very broadly defined and includes many occupations and tasks

Labor services are distinct from the other major types of inputs such as raw materials or capital services But wersquoll see that this distinction is not so clear for we will make use of the idea that people invest in their own skills which we will think of as human capital

In fact the labor market consists of many markets Labor markets differ in terms of location occupation and skill A labor market tends to be more like a single market to the extent that there is a high degree of mobility within it In this sense executives of Dhaka Bank and Dutch-Bangla Bank are probably in the same labor market but bankers and heart surgeons are not really in the same labor market at all

Keep in mind that not all work is bought and sold in labor markets Much housework and child care labor for example is performed by family members without pay Such work is not paid for in a market but it may have important implications for peoplersquos behavior in markets for paid labor because it constitutes an alternative use of a personrsquos time

Labor economics is an important subject because unemployment is a problem that affects the public most directly and severely So the full employment (or reduced unemployment) is one of the major goal of many modern governments

Introduction to personnel economics

Personnel economics (PE) is a relatively new but very active branch of labor economics The field has developed many ideas about workforce management and optimal personnel policies In addition the field is highly empirical This field has grown greatly in importance in the past 20 years

What is PE A typical definition would describe it as the subfield of labor economics that analyzes the design and effects of personnel policies A broader definition would recognize the strong complementation of PE with the economics of organizations The economics of organizations emphasizes the boundaries of the firm organizational structure and decision making These are closely related to personnel policies and involve similar economic trade-

4

INTRODUCTION TO LABOUR ECONOMICS amp PERSONNEL ECONOMICS

12

offs Moreover they are all of relevance to an executive responsible for setting or overseeing organizational policies

Traditional labor economics focuses on overall labor markets individual workers embedded in those markets (not just in a single firm at a point in the career) or public policies PE by contrast more often than not takes the perspective of the employer The typical objective in PE is to understand the optimal design and effects of personnel policies Instead of analyzing wage levels for the whole economy a personnel economist might think about how to design a firms salary system and whether that system enables the firm to meet its personnel objectives of recruitment retention training or incentives Empirical work in this area often uses personnel records from a single firm or collects information on the design of personnel policies across a set of firms precisely because the interest is in how to design those policies

This focus is one of the primary reasons why the field of PE holds promise as an important tool for research on organizational workforce policies Much of that research is intended to shed light on optimal employment policies for an organization

PE became a strong subfield in its own right somewhat separate from labor economics with two developments The first was the adaptation of the economics of information and other ideas from economic theory to applications inside organizations As the theoretical ideas advanced economists (especially those employed in business schools) began applying the ideas to understand the policies that a firm uses for its internal design and management of personnel Much of this early work was highly theoretical However the focus gradually evolved to a more practical focus A leader in this development was Edward Lazear who is generally credited as the primary founder of the field of PE Two excellent examples of his applied theoretical approach are his articles on salaries versus piece rate compensation plans and tournaments Both provided empirically testable predictions and practically implementable prescriptions

Personnel economists explore how the tools of sorting signaling and investments in human capital might be used by a firm to improve the quality of its workforce They have used the idea of signaling to analyze how a firm can improve recruiting quality by structuring the job offer so that workers who believe themselves to be a good fit are more likely to accept the offer while those who do not are more likely to reject the offer Application of economic ideas of sorting can be used to model how to structure a firms promotion system Economists have studied the effects of various kinds of promotion systems on the incentives for workers to invest in firm-specific human capital (skills that are valuable to the current employer) or general human capital (skills that are valuable to many employers)

PE developed as a subfield of labor economics over the last 20 years While labor economics tends to focus on labor markets--what happens across firms--PE focuses on what happens within firms PE has developed to such an extent that it has become recognized as an important subfield distinct from labor economics PE has a large group of researchers and has been very successful in theoretical and empirical research This line of study has many practical applications for how firms structure themselves and manage their workforces

PE holds great promise for contributing to research on organizational workforces It is based on the very strong foundation of classical microeconomic theory This foundation has enabled PE to develop a relatively comprehensive and rigorous way of thinking about organizational design This way of thinking does not replace traditional ways of studying organizations However it does provide a systematic framework for studying many issues

5

INTRODUCTION TO LABOUR ECONOMICS amp PERSONNEL ECONOMICS

12

using a consisted and tested toolbox The PE approach is complementary to other approaches but brings many new insights to the study of human resources

The focus of PE is generally on the firms perspective and on the design and effects of personnel policies Emphasis has usually been on practical theory that lends itself to empirics This approach is ideal for studying personnel records or similar data from organizations and for helping such organizations figure out more effective methods of managing their workforces While public sector organizations have different objectives and constraints than those of private sector organizations most of the trade-offs that they face are largely the same

6

• Definition and coverage of Labor Economics
• An overview of Labor Economics
• Distinction of labor and scope of labor economics

INTRODUCTION TO LABOUR ECONOMICS amp PERSONNEL ECONOMICS

12

offs Moreover they are all of relevance to an executive responsible for setting or overseeing organizational policies

Traditional labor economics focuses on overall labor markets individual workers embedded in those markets (not just in a single firm at a point in the career) or public policies PE by contrast more often than not takes the perspective of the employer The typical objective in PE is to understand the optimal design and effects of personnel policies Instead of analyzing wage levels for the whole economy a personnel economist might think about how to design a firms salary system and whether that system enables the firm to meet its personnel objectives of recruitment retention training or incentives Empirical work in this area often uses personnel records from a single firm or collects information on the design of personnel policies across a set of firms precisely because the interest is in how to design those policies

This focus is one of the primary reasons why the field of PE holds promise as an important tool for research on organizational workforce policies Much of that research is intended to shed light on optimal employment policies for an organization

PE became a strong subfield in its own right somewhat separate from labor economics with two developments The first was the adaptation of the economics of information and other ideas from economic theory to applications inside organizations As the theoretical ideas advanced economists (especially those employed in business schools) began applying the ideas to understand the policies that a firm uses for its internal design and management of personnel Much of this early work was highly theoretical However the focus gradually evolved to a more practical focus A leader in this development was Edward Lazear who is generally credited as the primary founder of the field of PE Two excellent examples of his applied theoretical approach are his articles on salaries versus piece rate compensation plans and tournaments Both provided empirically testable predictions and practically implementable prescriptions

Personnel economists explore how the tools of sorting signaling and investments in human capital might be used by a firm to improve the quality of its workforce They have used the idea of signaling to analyze how a firm can improve recruiting quality by structuring the job offer so that workers who believe themselves to be a good fit are more likely to accept the offer while those who do not are more likely to reject the offer Application of economic ideas of sorting can be used to model how to structure a firms promotion system Economists have studied the effects of various kinds of promotion systems on the incentives for workers to invest in firm-specific human capital (skills that are valuable to the current employer) or general human capital (skills that are valuable to many employers)

PE developed as a subfield of labor economics over the last 20 years While labor economics tends to focus on labor markets--what happens across firms--PE focuses on what happens within firms PE has developed to such an extent that it has become recognized as an important subfield distinct from labor economics PE has a large group of researchers and has been very successful in theoretical and empirical research This line of study has many practical applications for how firms structure themselves and manage their workforces

PE holds great promise for contributing to research on organizational workforces It is based on the very strong foundation of classical microeconomic theory This foundation has enabled PE to develop a relatively comprehensive and rigorous way of thinking about organizational design This way of thinking does not replace traditional ways of studying organizations However it does provide a systematic framework for studying many issues

5

INTRODUCTION TO LABOUR ECONOMICS amp PERSONNEL ECONOMICS

12

using a consisted and tested toolbox The PE approach is complementary to other approaches but brings many new insights to the study of human resources

The focus of PE is generally on the firms perspective and on the design and effects of personnel policies Emphasis has usually been on practical theory that lends itself to empirics This approach is ideal for studying personnel records or similar data from organizations and for helping such organizations figure out more effective methods of managing their workforces While public sector organizations have different objectives and constraints than those of private sector organizations most of the trade-offs that they face are largely the same

6

• Definition and coverage of Labor Economics
• An overview of Labor Economics
• Distinction of labor and scope of labor economics

INTRODUCTION TO LABOUR ECONOMICS amp PERSONNEL ECONOMICS

12

using a consisted and tested toolbox The PE approach is complementary to other approaches but brings many new insights to the study of human resources

The focus of PE is generally on the firms perspective and on the design and effects of personnel policies Emphasis has usually been on practical theory that lends itself to empirics This approach is ideal for studying personnel records or similar data from organizations and for helping such organizations figure out more effective methods of managing their workforces While public sector organizations have different objectives and constraints than those of private sector organizations most of the trade-offs that they face are largely the same

6

• Definition and coverage of Labor Economics
• An overview of Labor Economics
• Distinction of labor and scope of labor economics