When I began teaching labor economics at MIT in 1969, mainstream thinking in the field was dominated by a loosely organized school of economists who used their neoclassical training to investigate what went on inside large, specialized workplaces. Such information-challenged workplaces spread rapidly in the early 20st century. The GEM Project has named this school the Early Internal-Labor-Market theorists.
A keystone innovation of Early ILM literature is the reference wage (Wń). In the middle 20th-century, numerous on-site studies of workplace exchange found that employees prefer wages that are consistent with interpersonal and intertemporal reference standards that become ingrained (via repeated application) over time, evolving into a mainstay of workplace standards of acceptable treatment. The literary workplace analysis of Clark Kerr, John Dunlop, Richard Lester, Lloyd Reynolds, Arthur Ross, Frederick Harbison, Charles Myers, and others set the stage for the GEM Project’ generalization of rational exchange that microfounded meaningful wage rigidity (MWR) and chronic labor rent.
Original Great Idea
The great insight of the original ILM theorists is that optimizing labor-pricing decision rules, constraints, and mechanisms of exchange in highly specialized workplaces are inherently restricted by costly, asymmetric employer-employee information. They identified rational intra-firm mechanics that differ fundamentally from neoclassical behavior in the marketplace. As noted, they learned that workers resent being treated as a commodity governed by the impersonal interaction of supply and demand. They want, instead, to be taken out of the market. They also learned that workers in highly specialized establishments have sufficient on-the-job latitude to enforce that preference.
Dunlop (1994, p.380) succinctly described the separate-venue modeling by the Early ILM theorists: “The objective changes in the economy – within sectors, in the emergence of large enterprises and workplaces, and in the ideas and arrangements developed to govern and manage these workplaces – made it quite obvious to a new generation of economists in the 1940s, who were exposed in practical terms to labor markets and labor-management-government issues, that conventional (external) labor-market theory was grossly inadequate. It neglected a vast range of activities within the walls of organizations as well as their forms of interaction with exterior markets.”
The hands-on original ILM economists were close to providing an early solution to what has become a persistent, debilitating class of labor-related deficiencies in contemporary macro theory. They uncovered the facts but ultimately failed to construct a coherent theory of rational workplace behavior. As a result, they worked increasingly outside the economic mainstream. Kerr (1988, p.21) recognized the difficulty: “Perhaps the most serious problem … was that the revisionists dealt bit by bit with pieces of the puzzle and never assembled them into an integrated statement, let alone into a model or a consistent theory; and it takes a new theory to replace or change an orthodox theory.” Kerr et al. never derived a formal generalization of rational price-mediated exchange, but they did set the stage for that innovation by constructing a detailed roadmap to what actually goes on in modern employee-employer interaction.
The GEM Helping Hand.
The absence of an integrated, consistent theory eventually led to the abandonment of Early ILM thinking by mainstream labor economists. The Project’s helping hand revives the workplace venue of rational exchange pioneered by Kerr et al. GEM innovations in labor pricing and use are rooted in profit- and utility-maximizing behavior in information-challenged workplaces. Rational on-the-job behavior mandates labor pricing that is both downward rigid over stationary business cycles and chronically in excess of market opportunity costs.
Highly specialized workplaces correspond to Kerr’s (1954) “structured” markets, which he argued embody important institutional constraints. (Somewhat later, John Dunlop coined the term “internal labor markets”.) In the structured environment, firm boundaries relative to the market are more expansively drawn, making its workers a noncompeting group. Outsider access to jobs within the establishment is limited to specific ports of entry, typically the least desirable positions; existing employees have first claim on better jobs via promotion or transfer. Significant training occurs on the job as part of the general process of workplace socialization, featuring the acquisition of formal and informal firm-specific human capital and increasing the cost of labor turnover to the firm. Due-process rules, governing on-the-job interaction between employees and management, are characteristic of structured workplaces and “effectuate standards of equity that a competitive market cannot or does not respect.” Kerr emphasized that his “structured” and “unstructured” (market) wage-determination processes describe fundamentally different activity sets.
Is the Game Worth the Candle?
Early internal-labor-market theorists (Clark Kerr, John Dunlop, and their colleagues) ambitiously modeled, guided by their neoclassical economic training, employee-employer behavior in large, specialized workplaces. Their research remains central to proper macroeconomics. But their failure to root the modeling in optimization and equilibrium, the fundamental tenets of economic theory, resulted in being excluded from contemporary mainstream debate on the proper nature of macroeconomics. That the GEM helping hand should allow the important work of Kerr, Dunlop, et al. back into the conversation is surely worth the candle.
Blog Type: New Keynesians Saint Joseph, Michigan