Labour Demand, Supply & Equilibrium

1.0 INTRODUCTION

Labour economics seeks to understand the functioning of labour markets and how they impact
supply, demand and wages. Essentially, if demand for a specific labour category is high and supply is
low, then the expectation is that wages will increase to attract more workers into the sector. Labour
economics is important given the result it has on wages, income and unemployment, with many
governments around the world seeking full employment as it would raise incomes and reduce
welfare dependence.

However, this basic argument assumes that the labour market operates perfectly. However,
inefficiencies lead to an imperfect market shaped by:

 Compensating Differentials. A worker may be given lower wages because they receive
compensation in the form of other (hard-to-observe) job/roles characteristics e.g. lower
effort requirements and better working conditions.

 Labour Market Imperfections. Two workers that are essentially the same may be paid
differently because of job/role variations which shape both productivity and reward
mechanisms. For example, a larger business may be able to offer better pay and benefits
than a smaller company for exactly the same effort.

 Direct Discrimination. Employers may pay lower wages to some workers due to institutional
preferences e.g. around ethnicity, gender and nationality.

Elasticity of demand must also be considered. If a business is in a highly competitive sector with
elastic product pricing (i.e. any price increase has the potential to significantly reduce demand) then
they will be unable to offset higher wage demands by raising the prices charged for their outputs.
Globalisation also shapes this dynamic, with many businesses now able to take forward overseas
sourcing and manufacture to maintain or increase outputs whilst still minimising wage costs.

Substitution between the cost of labour and the cost of capital i.e. replacing workers with machinery
can also shape the market. If wage costs increase significantly, then businesses will look to other
solutions (such as increased automation) to reduce this overhead. National economic and social
policies designed to protect the wage interests of workers can also (unintentionally) increase this
pressure e.g. the UK National Minimum Wage legislation.

In examining such factors, the labour market can be considered in both microeconomic and
macroeconomic terms. Macroeconomics refers to the overall economy and so consider
interrelations between labour markets, trade and money markets. The government can intervene in
the economy to change the macroeconomic situation such as through wage legislation, education
policies to increase workforce skills or economic approaches (such as international trade agreements
and taxation) to stimulate and increase aggregate demand. Microeconomics focuses on individual
businesses and workers in order to examine their role in the labour force.

2.0 HUMAN CAPITAL

Human capital can be considered as a set of skills that can be used to increase worker productivity. It
can be seen as a stock of knowledge and know-how, mental and physical abilities and/or the
capacity to adapt and learn. However, this is a challenging concept given the nature of change being
experienced within national economies as workers seen as highly skilled and ‘rare’ assets in the past
(e.g. miners) seek to address real and perceived barriers in an effort to gain employment in
new/emerging business areas.

National education policies seek to provide a future workforce that is equipped to meet such
demands, but these approaches favour new entrants to the labour market rather than established
workers whose current skills may no longer be in demand. Establishing the cost-benefit return of
education investment in older workers is more challenging, particularly when social support costs
and associated factors (e.g. status and community impact of unemployment) are considered.

3.0 WAGE STRUCTURE

The wages offered by a business will generally depend upon the supply/demand fundamentals of
the market. However, with the globalisation and automation issues already noted, there are now
choices available to businesses which may depress or limit wage rates. In some sectors, the
perceived ‘pay-back’ of the worker rather than productivity is seen as the key wage determinant e.g.
workers in hospitality and service areas being paid lower rates per hour than those in the financial
sector.  This neo-classical view suggests that a worker will earn a wage equal to their marginal
product of labour, but this assumes the operation of a perfect market. In reality, this may not be the
case, with some businesses making abnormal profits from workers and paying at rates which are
below the marginal product of labour. It can also be argued that some manufacturing roles should
receive a lower wage if the process concerned could be undertaken by machinery, particularly if this
could be a more cost-effective option.

Generally, there is a wage incentive for many workers - work harder and earn more and some
legislative policy interventions seek to shape this decision space e.g. the UK National Minimum Wage
seeking to increase workforce participation by making state benefits less attractive. However, such
incentivisation will only work as long as workers are content to substitute their available leisure time
for labour. Once income levels reach a certain level (so that their core requirements are satisfied)
then workers are more likely to protect their remaining leisure time. Essentially, at this point the
marginal utility of leisure time exceeds that of work/labour time.

4.0 UNEMPLOYMENT TYPES

Cyclical unemployment is created by a general downturn in the economy which causes aggregate
demand to fall, reducing labour requirements and therefore increasing unemployment rates. This
can also be described as ‘Demand Deficient Unemployment’, as there is insufficient aggregate
demand for full employment to be achieved in the economy.

In the UK, the main driver of aggregate demand has been consumer spending, with commentators
suggesting that future growth needs to be driven by investment, trade and increased exports.
Continued globalisation has allowed some countries to increase national employment through
international demand for their products and services rather than rely on domestic requirements.

Structural employment is caused when certain national industries decline, reflecting long-term
changes in the market (e.g. due to technology changes and/or alternative/cheaper overseas supply).
The long-term impact of this will be dependent on a range of factors such as other sector/regional
opportunities, training availability and impact as well as workforce flexibility. Structural
unemployment can be driven by regional concerns (the lack of any viable alternatives to the industry
lost) and seasonal variations (such as agricultural workers and those in the tourism industry). 

Classical unemployment reflects the traditional supply/ demand model, stating that unemployment
will occur when the wage demands are too high. Frictional unemployment reflects the hiatus that
occurs when a worker is ‘between’ jobs (e.g. made redundant but with the skills to be re-hired
elsewhere). Because of this liquidity in the labour market, it can be argued that an unemployment
rate of between 3-4% is a closer reflection of full employment. The impact of voluntary
unemployment on the market must also be considered given the factors that may lead people to
exclude themselves from the workforce. Social concerns - such as attitudes to the employment of
women and discriminatory attitudes (e.g. surrounding the perceived abilities and adaptability of
older workers) are key issues in this area.

5.0 LABOUR PRODUCTIVITY AND PRODUCTION FRONTIERS

The production frontier considers the possible production of goods in an economy. Essentially, given
current inputs, the economy can produce up to a certain level but for workers to achieve above
inflation pay increases productivity also needs to increase. Doing so increases corporate revenues,
creating the margins needed to potentially increase wages.  If productivity slows, the economy
contracts, aggregate demand decreases and there is downward pressure on wages. If productivity
increases, not only is there an increase in corporate margins the associated wage increases may also
stimulate consumer demand (people can buy more!) which can sustain the pull for the higher
productivity levels being achieved.

It can therefore be argued that productivity growth is vital for long-term sustainable growth and that
this is achieved through two key inputs - labour and capital. For a country to increase the size of
their economy, they need to either increase the size of the labour force, or invest in the market to
expand productivity. However, this is relatively simplistic given some of the social factors already
outlined and the impact of emerging factors such as automation.

6.0 LABOUR MOBILITY

Labour mobility refers to worker movement around an economy or even internationally.

Geographical mobility refers to location, whereas occupational mobility refers to the worker’s ability
to change job types. Geographic mobility can increase the supply of labour (e.g. moving from rural to
urban environments to support manufacturing) and can deliver both specialisation and comparative
advantage. For example, in China, the move of cheap (previously agricultural) labour into large cities
allowed specialisation in large volume, lower quality goods for export at prices which were difficult
for competitors to mirror.

A mobile labour force can also mitigate the impact of regional/sector unemployment as people
move to exploit other opportunities. Productivity can also increase when geographic, more
specialised labour clusters develop allowing shared innovation and associated skills development.
Examples include ‘Silicon Valley’ in the United States and the UK financial sector in London.
International labour movement can be either facilitated or restricted by treaties and collective
economic agreements as well as national policies such as work visa requirements.

Occupational mobility, whilst essential to the transformation of any economy, does require national
policy support through interventions such as training and education opportunities for older workers.
It can also be restricted if the sector(s) concerned are too heavily regulated which can inhibit the
free flow of labour. However, in many roles such regulation and associated licensing and training
requirements are deemed essential (e.g. medical professionals). In these areas, higher wages can be
commanded due to both high demand and restricted supply.

7.0 UNIONS AND COLLECTIVE BARGAINING

Employee representational groups such as Trade Unions play an important role in areas such as
collective bargaining and associated pay issues. However, there has been a large decline in union
membership over the last few decades which in turn has eroded the collective bargaining power of
such entities. Unions might seek to exercise their collective bargaining power with employers to
achieve a wage premium compared to the rates available to non-union members. Their focus also
includes skills development, the protection of workers’ rights and supporting both occupational and
geographic labour mobility. Unions retain the power to restrict the supply of labour, although within
the UK this is now highly regulated and controlled through legislation.

8.0 SUMMARY

This Chapter has sought to outline the key economic arguments in relation to the operation of
labour markets. Ultimately supply and demand will determine wage rates, but as has been shown
this dynamic is complicated by a number of factors. The importance of productivity and the
elements shaping aggregate demand have wider implications of the economy, especially as growth
in consumer spending may be needed to increase job opportunities, sustain growth and create the
margins needed for wage increases. 

The nature of human capital also affects the wage structures that are likely to materialise and the
importance of education, skills and skills transfer must not be underestimated. As workers acquire
more skills/ capital the demand for their services increase as they are seen to be able to support a
business in its aspiration to improve/increase productivity. However, the wages offered must be high
enough to generate positive utility - in essence, it has to be worth the worker’s time and attractive
enough for them to sacrifice alternative opportunities such as increased leisure time. 

This Chapter also discussed the challenges surrounding unemployment and the social and economic
issues that shape unemployment rates. The structural challenges that may be present in a national
economy (such as limited labour mobility and limited skills re-training opportunities) can exacerbate
the economic impact of unemployment, further undermining economic growth
aspirations/expectations. It is also necessary to maintain an international view of labour economics
given the drivers behind globalisation and the increased labour competition that results.

Labour Demand, Supply & Equilibrium

Labour economics seeks to understand the functioning of labour markets, and how such
impacts on supply/ demand and wages. As with other goods in the economy, labour demand
and supply can be graphically represented as shown below:
Figure 1 - Visualisation of supply/ demand.

In this case, the price (i.e. wage rate) offered to the employee will be dependent on the supply
of labour in that sector compared with the demand for that labour. Essentially, if demand for
a specific labour is high and supply is low, then the expectation would be that the wage rate
would increase to attract more supply into the sector - read Sloman et al (2013). Specifically,
when talking of labour, skills could be considered as the commodity which is being traded.
Essentially, to encourage more workers to acquire a specific skill, the employer will offer a
higher wage rate. An example of this may be a manufacturer offering a high salary level to
attract more workers to acquire the needed skills, meeting demand. Labour economics is
important given the result it has on wages, income and unemployment, with many
governments around the world seeking full employment. As suggested by economic models
such as Solow Growth, full employment would result in greater employment in the economy,
in turn rising income, and reducing welfare that may be associated with unemployment
benefits.

The above description would suggest that the labour market is operating perfectly. However,
there can be inefficiencies in the system that leads to an imperfect market; consider reading
Sloane et al (2013). For instance:

(1) Compensating differentials: a worker may be given lower wages because he is receiving
part of his/ her compensation in the form of other (hard-to-observe) characteristics of the job,
which may include lower effort requirements, more pleasant working conditions, better
amenities etc.

(2) Labour market imperfections: two workers with the same human capital may be paid
different wages because jobs differ in terms of the role, and from this their productivity and
pay. For instance, a leading accountancy business may pay their worker more than that at a
smaller firm, even though the specification is the same.

(3) Direct discrimination: employers may pay a lower wage to a worker because of the
worker’s gender or race due to their prejudices.
However, with this, the elasticity of demand must also be considered. This elasticity will be
dependent on the business in question. For instance, a business will consider labour costs as a
% of total costs. If the business is in a highly competitive industry whereby the prices of their
products are elastic, then they may have little power to push through higher prices if needed
to offset higher wages. What could also be mentioned here is that with globalisation there are
now a number of choices available to businesses. For example, if workers in the UK demand
higher wages, then the business may consider relocating their operations internationally, to a
country such as China/ Indonesia where the wage rate may be lower. These finished products
can then be imported back into the UK and sold at the current price, essentially reducing the
costs for the business.

Finally, there is also a level of substitution which must be considered between the cost of
labour and capital substitution. For example, labour demand will be more elastic when the
business can quickly substitute the labour for capital inputs; i.e. replacing workers with
machinery. If wages rise too high, then businesses may look to invest into machinery or
automate some processes to reduce the costs of labour. To visualise this, consider the UK
retail sector, a sector which is coming under recent pressure from increase competition, rising
inflation and slowing economic growth. At the same time, the UK government is seeking to
rise the National Living Wage at a time when further growth in UK worker productivity is
providing elusive.

With this in mind, consider a retailer who facing increasing wage costs while the productivity
of that worker is not necessarily increasing, or bringing in extra revenue to compensate for
the higher costs. Ultimately, the profitability of the business will decrease, prompting
management to consider cost cutting measures. This could impact on labour, especially as
mentioned above if there are chances to substitute labour for capital, or to move the labour to
a cheaper location.

Taking the examples above, the labour market can be considered in the microeconomics or
macroeconomics sense. Macroeconomics refers to the overall economy and so consider
interrelations between the labour market, trade and money markets. For instance, the
government can intervene in the economy to change the macroeconomic situation, be it
introducing a set minimum wage to incentive more engagement within the labour force; make
changes to the education sector to increase the skill-set within the economy, or change
policies in business/ taxes etc., i.e. free-trade agreements to make the economy more
competitive and increase aggregate demand. Microeconomics focuses on the individual
businesses/ workers, considering their role in the labour force.

1.1 Human Capital

The basic approach to labour economics would consider human capital as a set of skills/
knowledge that could be used to increase productivity from a worker. This is a useful starting
point, however there are some researchers who consider an alternative view:

1. The Becker View – The idea here is that human capital is directly related to the
production process, and should be viewed as a stock of knowledge in the worker. An
un-dimensional object represents this, be it knowledge, or know-how etc.
2. The Gardener View – this view is similar to that above, however there is this idea that
capital can be split into mental vs. physical abilities, meaning that some may be
 dimensional. The idea here could be that some workers may be better suited at a task
given their abilities; be it their strength etc.
3. The Schultz/ Nelson-Phelps View – human capacity is viewed as the capacity to
adapt; suggesting that a business is able to adapt its workforce to a changing
environment, be it through training/ education.

The main difference between these theories is how their distinguish the source of human
capital, be it something which is instilled within a worker from birth, or be it something
which can be developed with education, training. This is an interesting concept in many
advanced nations as the economy transitions. For instance, consider the former mining towns
in the UK. Some of these areas continue to suffer with persistently high unemployment even
now given failures in retraining former miners to appeal to new industries, i.e. IT. This shows
that it is not always so easy to acquire the new skills in the workforce; there are barriers to
overcome.

For instance, one may be a barrier into education. A former miner may seek to retrain for
employment in the financial industry, however they may be stopped by the cost of the
training needed, be it professional courses, or further education such as a University degree.
In this case, the worker needs to consider the options available to them and the differential of
education; be it the extra income earned which can then be traded off with the costs of
education. However, by doing this, it could be noted that education/ training prefers the
young. For instance, consider two workers, one who is 22 and one who is 40; also assume
that the retirement age is 66. Each considers further education at a cost of £50,000 that they
hope will increase their employability, getting them on average £2,000 per year. For the 40
year old who has 26 years of work left, an extra £2,000 per annum would represent an extra
£52,000 over their working life, one marginally more than the cost of the education, while for
the 22 year-old it is £88,000; providing a greater financial benefit.

1.2 Wage structure

When it comes to determining the wage structure, the wage rate offered by the business will
be dependent on the supply/ demand fundamentals of the market. So, as mentioned if there is
a shortage of labour in a specific industry, the business will try and attract more labour
through increasing the wage rate. However, there are now other factors to consider. For
instance, with globalisation and automation, there are now substitutes/ choices available to
businesses which may provide a ceiling to wage rates.

In some industries, wages may be kept lower given the productivity, and so the payback of
the worker to the business. For instance, workers in hospitability/ service sectors are
generally paid less than counterparts in finance given that they return less financially to the
business. According to the neo-classical view on labour markets, a worker will earn a wage
which is equal to their marginal product of labour, however this is assuming that the labour
market operates in a perfect market. In reality, this may not hold, with businesses seeking to
make abnormal profits from workers, which in turn will see them pay a wage rate below the
marginal product of labour.

Furthermore, there is the argument that some manufacturing roles may command a lower
wage rate given that the process being undertaken could be replaced by machinery. As noted,
if the wage rate does move too high, then it may be financially viable for the business to
substitute labour for capital.

A neoclassical model can be considered here:

‘U’ refers to total utility, suggesting that the worker will look to maximise their total utility.
This will be done given the parameter of total time available (denoted by k), with the worker
choosing between working (L), and leisure time (A). Essentially, the choice will be
dependent on the wage rate offered for working (denoted as w), compared with the income
that could be earnt from non-labour sources, also seen as the utility which could be derived
through leisure (π). What this equation suggests is that the choice for the worker is a trade-
off; if wages do increase higher then there is a higher incentive to work more. It could be
considered here that a driver behind the introduction of the National Living Wage in the UK
has been to increase participation in the workforce, making it financially beneficial for those
on benefits to seek work.

Figure 2 below shows an example of the backward bending labour supply curve. So, say that
a worker begins at point S, whereby their wage equals W0 and so they work L0. However, as
their wage rate is increased they are incentivised to work more, seen as the substitution effect
given that the worker will substitute leisure time for labour. This will continue until they
reach point T., when the substitution effect may be displaced by the income effect. After this
point, a higher wage will push the worker to cut back on their hours worked given that they
are happy with their current income level. It could be said that the marginal utility of an extra
leisure hour here is greater than the utility from dedicating more hours to labour.

Figure 2 - Backward bending labour supply curve.

1.3 Unemployment types

A number of types of unemployment can be discussed, influenced by either macro, or micro
events. For instance, cyclical unemployment can be mentioned. This type of unemployment
is created by a general downturn in the economy, causing aggregate demand to fall. With this,
there is less need for labour in the economy, and so unemployment will rise. Taking UK
unemployment data (see below), the unemployment rate peaked at 8.5% during the financial
crisis, before falling back in the following years, however this was lower than the 11.9%
recorded in 1984. Some others may also refer to this situation as ‘Demand Deficient
Unemployment’, essentially suggesting that there is insufficient aggregate demand for full
employment to be achieved in the economy. However, this may be dependent on the
economy in question, and the components which are driving aggregate demand.

Figure 3 - Data table acquired from the ONS (2017)

Aggregate demand can be seen in the following equation:

Aggregate Demand = Consumer Spending + Investment + Government Spending +

(Exports - Imports)

When it comes to the UK, the main driver of aggregate demand has been consumer spending,
with recent commentary from the Bank of England suggesting that the UK needs to drive
future growth from investment and trade, with exports being increased. This is important to
consider given that continued globalisation has allowed some countries to increase their
employment through international demand as opposed to just domestic aggregate demand; for
instance, China. However, globalisation has come with negatives to the labour market,
negatives which can be seen when structural unemployment is considered.

Structural employment is caused when certain industries decline, potentially by long-term

changes in the market. Following on from the example of China above, it can be noted that
the UK has lost a number of manufacturing roles over the years as businesses relocate to
China where wages are lower. With this, jobs are transferred abroad, leaving structurally
employed workers. The long-term impact of this will be dependent on a number of factors,
including the ability for such workers to be re-trained, or the other opportunities which may
be available to them in the local economy.  However, in some cases this structural
unemployment could become long-term, even if the economy is performing well. There are a
number of reasons to mention here, including (1) that it may be difficult to retrain workers
into sectors which may offer them comparable benefits (i.e. pay) to their previous roles, or (2)
the local economy may have few other opportunities available, with the loss of the
manufacturing plant hitting other areas of the local economy such as services.
This can also be seen as regional unemployment. For instance, if the UK is considered,
coalminers from South Wales or ship workers from the North East are cases of regional
unemployment, with the region unable to ‘regenerate’ given a lack of opportunities available
to displaced workers. Similar to this could be seasonal unemployment which may also be
seen as regional. For instance, in the UK, seaside resorts such as Blackpool/ Cleethorpes
suffer from seasonal unemployment given the need for more workers during the summer
months. Seasonal employment could be seen in industries ranging from tourism, to farming
and construction.

Three other types could be seen as classical, frictional and voluntary. Classical
unemployment is built with the traditional supply/ demand model in mind. The main idea
here is that unemployment will occur when the wage rate being demanded by workers is too
high. Some theories argue that this type of unemployment is the blame of the employee’s for
demanding too high of wages; which in turn restricts from the economic reacting full
production. This could also be considered when the introduction of a minimum wage is
considered. For instance, in the UK the trajectory of the UK National Living Wage has
prompted some worries that it will lead to higher unemployment as some businesses,
particularly those in the service/ hospitality sectors looks to cut jobs and seek to increase
productivity from remaining staff to remain profitable.

Frictional unemployment is seen when a worker has lost their job and in the process of
searching, and applying for a new role. Given the process, this is not instant, instead the
worker may be classed as unemployed for a number of months while this move from one job
to another. Given this, many economies consider full employment to be between 3-4%, with
commentary recently from the U.S. considering that the economy may be moving close to
full employment as unemployment falls to 4.4%. Commentators consider full employment to
be closing in when wage growth increases in the economy, pointing to a shortage of workers.

Finally, voluntary unemployment must also be considered, which may be seen when some
people choose to remain out of the labour force. For instance, in the UK the labour
participation rate is --, while that of the U.S. is 62.8%. In some communities there may be
customs/ social reasons which deter some from entering the workforce, i.e. women. On the
other hand, there may be discrimination which could deter others from participating including
older workers, all which will decrease the participation rate in the economy.

1.3.1 Example - U.S. Economy

As mentioned, the U.S. unemployment rate is currently at 4.4%, with some commentators
mentioning that this could be a sign of full employment within the economy. However, as
shown in the chart below, while the participation rate is increasing, it remains lower than the
% seen pre-crisis. Taking this into account, it could be considered that the current 4.4%
unemployment rate is under reporting the actual rate. For instance, if the wage rate was to
increase in future, then more workers may seek to re-enter the workforce, pushing up the
supply of workers and potentially increasing the unemployment rate if there isn’t sufficient
demand.

1.4 Labour Productivity and Production Frontiers

The production frontier provides a visualisation of the possible production of goods in an
economy. Essentially, given the current inputs, the economy can produce up to any
combination on the frontier curve. However, it could be mentioned that for workers to
achieve above inflation pay increases, raising living standards, productivity needs to be
increased. By increasing productivity, the worker is producing more goods for the business,
in turn bringing in more revenue. The table below has been taken from the Office of National
Statistics (UK), showcasing the recent slowdown in UK productivity growth from the 2009
recession. Taking the data, productivity in 2007 has only just surpassed the level seen in Q4-
2007 when the index was set at 100.

Figure 4 - Source ONS (2017). UK Labour Productivity

The main issue with this slowdown in productivity is that it hinders further expansion in the
economy, with the dotted line above showcasing how productivity may have been if it
continued on its pre-crisis trajectory. Furthermore, there is also a linkage with wages; if the
worker is more productivity they earn more for the business, allowing the business to pay
them more. With this, the consumer may spend more as their income increases, driving
aggregate demand in the economy and further increases the size of the economy. So, thinking
this way it can be concluded that productivity growth is vital for long-term sustainable
growth. This can be seen in the Solow Growth Model, who considers that long-term
sustainable growth can only be achieved through two inputs, namely labour and capital. For a
country to continually increase the size of their economy, they need to either (1) increase the
size of the labour force, or (2) invest into the current labour market to expand productivity
through capital expenditure (hereafter CAPEX).

When productivity is considered there are a number of ways in which a business can seek to
raise their levels. For instance, the general assumption is that productivity fell during the
2008 financial crisis given that businesses reduced investment given weaker economic
fundamentals, restricting the deployment of new technology. It could be noted that prior to
the crisis, a continued rise in productivity had been supported by greater implementation of
new technology, in many cases allowing for tasks to be automated. Other factors which could
be considered are greater education/ or training to the workforce. However, there is a
downside, with recent reports noting how greater automation could lead to greater job losses
in the future, in turn increasing unemployment. Specifically, some economists now worry
over how advancements in robotics may impact on employment within specific industries, be
it manufacturing or on the service sector, i.e. hospitality.

1.5 Labour Mobility

Labour mobility refers to the ease with which workers are able to move around an economy,
or internationally, a theory which will link directly with the economics of unemployment and
labour supply/ demand. It is important to study labour mobility as it can be a major influencer
on production, productivity and so economic growth. When it comes to mobility, there are
two main types to focus on, namely geographical and occupational. Geographical mobility
refers to the worker’s ability to work in a particular location, be it domestic or international
etc. Occupational mobility refers to the worker’s ability to change job types, i.e. from
manufacturing to retail etc.

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1.5.1 Example in the UK

For example, consider a worker in the UK who currently lives in Manchester, but has now
been offered a job in London. There are a number of barriers which could stand in the way of
the worker moving, be it finding an affordable house in London, family ties in Manchester,
social reasons, money etc. In a perfect economy, there would be no barriers allowing the
worker to move into this job, although this is not the case. When international moves are
considered, then there are other complexities to consider, i.e. visas, local cultures etc.

Occupational mobility could also be considered here. Assume that the worker had previously
worked in a manufacturing plant, however after the plant closed and moved production to
China the worker was left unemployed. To regenerate the local economy, IT/ financial
businesses are now being attracted to set up offices in the local area. However, there are still
barriers here, mainly when it comes to the worker transferring their skills, or developing new
skills which would be required by these occupations.

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Taking this into account, there are a number of reasons why geographical mobility does
matter to labour market:

1. Increase the labour supply: The mobility of labour could be important for economic
development when it comes to expanding the supply of labour in an economy. For
instance, the Chinese economic growth story was supported by urbanisation, and by
the movement of people from rural villages into the burgeoning cities. This mobility
of labour increased the available workforce to manufacturers in China, providing the
country will a large pool of cheap labour.

Added to point (1) above comes the concepts of specialisation and comparative advantage. In
the case of China, the supply of cheap labour into its burgeoning cities allowed it to develop a
comparative advantage globally in the manufacture of a number of consumer goods, leading
to specialisation which supported its export-growth model. Specialisation can also be noted in
a number of other countries, especially when it comes to the development of a ‘cluster’ of
business. For instance, London in the UK holds a ‘cluster’ of financial businesses, a cluster
which in turn has been supported by the supply of skilled labour, supported through mobility,
both domestically in the UK and internationally, particularly given the EU, and the free
movement of people.

2. Unemployment: Secondly, mobility matters given the impact that it could have on
unemployment. As mentioned above, there could be cases where the supply of labour
exceeds demand, requiring the mobility of labour. Furthermore, while there may be
the labour supply in the local economy, the current supply may not necessarily be
trained up to meet demand, which in turn may require mobility of labour.
3. The mobility of labour also becomes interesting when discussing productivity of
labour. For instance, the examples above with China have mentioned how the country
was able to build a comparative advantage in the production of manufactured goods
given the large pool of cheap labour. At the same time, productivity also comes into
question, especially when the development of a business ‘cluster’ occurs. The
mobility of labour into a specific geographical area could create an advantage for
businesses seeking to locate. For instance, Silicon Valley in San Francisco has
continued to expand as new businesses are attracted to the area given the local pool of
skilled labour, created through the mobility of labour.

A reduction in geographic restrictions can be reached in several different ways. Between

countries, it is accomplished through treaties or economic agreements. Countries can also
increase the number of worker visas available, or reduce the requirements of receiving one.
For example, countries that are part of the European Union have fewer restrictions on the
movement of labour between members, but can still place tight restrictions on labour
movement from non-member countries.

The effectiveness of improved geographic mobility will ultimately depend on individual

workers. If economic opportunities are not available in a different country or in a different
part of one's current country, the likelihood of an employee wanting to make a change will be
diminished.

There are also a number of factors which are impacted by occupational mobility. For
instance, occupational mobility will be key to transform an economy, providing workers with
new skills and new opportunities which could avert unemployment. Occupational mobility
could provide support to nascent industries wanting to grow; for example, the movement
away from labour intensive manufacturing to more high-end technical manufacturing and
engineering. Mobility could provide SME’s[1] with the workers they need to expand their
operations. If not, a shortage of workers could impact on the production possibility, and
productivity of the business, which in turn may impact on the competitiveness of the
business.

Occupational mobility could also aide businesses in keeping costs lower, especially through
lower wages. As mentioned with supply/ demand, if there is a supply shortage of workers,
then the expectation would be that the wage rate would need to increase to attract more
workers. However, if the wage rate does increase too high, then producing the items may
become unprofitable, and so business may fail to reach full production. However, by
increasing the supply of labour then the wage rate can decrease, reaching an equilibrium
which is beneficial for both the business and the worker.
Occupational mobility can be restricted through regulations. Licensing, training or
education requirements prevent the free flow of labour from one industry to another. For
example, restrictions limit the supply of physicians, since specialized training and licensing
is required to work in that particular profession. This is why physicians can command higher
wages, because the demand for physicians coupled with a restricted supply increases the
equilibrium wage. This funnels unqualified members of the labour force into industries with
fewer restrictions, keeping the wage rate lower through a higher labour supply compared to
the amount of labour demanded.

1.6 Labour Unions and Collective Bargaining

When it comes to labour markets, labour unions who are also known as ‘Trade Unions’ are
an important factor. Some industries use trade unions as a means of collective bargaining
when it comes to pay and other issues in the workplace. Trade unions are organisations which
seek to improve the real incomes of workers, provide job security etc. In the UK, some of the
biggest unions include ‘Unite’ and UNISON, the public sector trade union, however there are
also specific unions for specific roles, including the NUT, who represent teachers.

However, there has been a large decline in union membership over the last few decades
which in turn has eroded some of the bargaining power which these unions would hold on
employers. Unions might seek to exercise their collective bargaining power with employers
to achieve a mark-up on wages compared to those on offer to non-union members. For this to
happen, a union must have some control over the total labour supply. In the past this was
possible if a union operated a closed shop agreement with an employer – i.e. where the
employer and union agreed that all workers would be a member of a particular union.
However, in most sectors, the closed shop is now history. With this, the choices available to
trade unions has diminished when it comes to action.

Focusing on 2017, the UK has already seen a number of actions involving trade unions, with
the most popular being strike action which as touched upon above would be seen as
restricting the supply of labour. Walkouts have already been seen on the railway in Northern/
Southern Rail strikes, with British Airways, and within the public sector; be it the NHS or
Education.

1.7 Chapter Summary

This section will now provide a summary on the economics behind labour markets.

To start, the first section mentioned that labour markets are determined like goods, with
supply/ demand. Ultimately, this relationship will help determine the wage rate offered to the
worker for the role. However, as touched upon, this has become an issue in many advanced
economies as productivity growth has slowed. Taking the latest figures from the UK,
productivity slid by 0.5% in Q1-2017, with some commentators suggesting that it takes a
British worker 5 days to produce what a worker in Germany can produce in 4 days. The main
issue here would be how this lax in productivity then impacts on wage growth. As showcased
in the aggregate demand function, this can then have wider implications of the economy,
especially onto growth in consumer spending which may be needed to increase job
opportunities and further growth.
Moving on, the next section considered human capital before discussing wage structure.
These two are directly linked; with education/ skills generally leading to higher wages. The
basic idea behind this is that as workers acquire more skills/ capital they become more in-
demand given the productivity that they can bring for a business. For instance, consider that a
judge will be paid a higher wage than a bartender; which can be explained given (1) human
capital development, and (2) how this impacts on the supply/ demand fundamentals for the
specific job role. However, with this, it was also mentioned that the wage offered to the
worker needs to be high enough to generate a positive utility, one which is higher than the
utility offered by leisure time, in turn encouraging workers to work more hours.

From this, the chapter then moved into discussing unemployment. Whilst unemployment is
classed as the number of people who are looking, and without a job, there are several reasons
which split how we can distinguish unemployment. For instance, unemployment could be
caused by regional economic disappearances, which in turn may cause structural
unemployment. For example, it was mentioned that unemployment has been high in some
Northern UK towns for several years given the decline of manufacturing and heavy industry.
For the displaced workers, it may be difficult to find another job, especially if the job may
require re-training, OR may offer them less benefits than the previous. There was also a
mention that some unemployment could be hidden as workers leave the workforce. For
instance, the U.S. has a much lower participation rate than the UK. If wages rose, and more
opportunities became available, then the participation rate may increase.

1.8 Practical Example

This section will now provide an overview of labour in economics, providing some practical
examples to explain theory. Like other goods, labour is considered as a supply/ demand
function, with the economy seeking to reach an equilibrium point. Where demand/ supply
intercepts would be the price, and so the wage rate offered to the worker. As with goods, if
supply is greater than demand, then the wage rate will fall, however the difference in the
labour market is that some countries have minimum wage legislation in place which restricts
the wage rate falling too much.

To increase the prosperity of the country and drive economic growth, real wages need to
increase. ‘Real’ is an important word as real wage growth would be seen as the wage growth
after inflation is taken into account, rather than nominal wage growth which does not
consider inflation. If real wages are increasing then living standards are increasing, in turn
allowing consumers to increase their demand and spending. Aggregate demand can be
considered with the following equation:

Aggregate Demand = Consumer Spending + Investment + Government Spending +

(Exports - Imports)

As you can see, consumer spending is an integral part of economic activity. As well as being
driven by productivity/ and so the business, the wage rate could also be dependent on the
workers themselves, and their desire to work. With this in mind the neoclassical model can be
considered:
What the above is saying is that the worker will look to maximise their utility between labour
(L) and leisure (A). If the wage rate is too low, then some workers may consider to denote
more time to leisure given that it offers a greater utility. As known, the main objective for an
individual could be to maximise their own utility. On the other hand, as the wage rate
increases too high, then a worker may start to denote more time to leisure given that the
utility from this is higher than for the extra income which would be received. Taking this into
account, this function can be visualised as a ….

Unemployment exists in all economies; some may be classed as natural unemployment and
be seen as workers change jobs etc. Other unemployment may be structural, and caused by
the decline of certain industries, be it manufacturing/ mining etc. While the economy may
diversify, and provide jobs in other sectors, there may be barriers which restrict workers from
changing jobs. For instance, consider how difficult it would be for a former coalminer in the
North UK to move into an IT-related job. First and foremost, of the barrier of education/
training, with the worker’s current skillset un-transferable for a role in IT. There may be the
need for further training which has the barriers of cost and time. This is where the
government can potentially help, with a key focus of the welfare system in the UK being
offering workers training to make them appeal to employers. However, even if the barrier of
human capital is overcome, there is then the consideration of location. Regional
unemployment is also an issue in the UK, with many commenting that UK economic growth
has been centred on London. So, even if the worker did re-train for a role in IT, many of the
jobs may be in London. With this, there would then be barriers to labour mobility, including
the cost of the worker moving from the North UK into London as well as family ties etc. In
some cases, there is then the consideration that some workers could leave the workforce,
pushing down the participation rate, but in turn keeping the actual unemployment rate low.

To overcome these issues with unemployment, the government can make changes with
policy. For instance, the government could provide financial incentives for businesses to
locate within a certain area of the UK. This may allow for jobs to be created, creating a
multiplier effect in the economy, leading to better economic prospects. For instance, the
opening of a new manufacturing facility in the town may lead to more employment within the
construction sector, the supply-chain, and the local service sector which will benefit from
higher spending from the workers. Other ways in which the government can help would
including greater training/ education facilities (as mentioned provided through the welfare
system), as well as greater spending on infrastructure. For instance, consider the proposed
HS2 development from the government which will bring high-speed rail to the UK and cut
journey times between major cities London, Birmingham, Manchester etc. The benefit here is
that it will increase mobility in the economy, increasing business activity. Similar is the
‘Crossrail’ project in London, reducing journey times into central London from surrounding
boroughs. The benefit again is it increases labour mobility, making it easier to reach jobs
available in central London. It also helps reduce some barriers to labour mobility; for
example, the high cost of housing in London. Finally, it could also be mentioned that the
government introduce regulation to improve labour standards, reduce discrimination and
increase the ‘Utility’ gained from working. The main factor here would be the introduction of
the minimum wage, more recently the National Living Wage in the UK. Increasing this
makes to more attractive for those out of the labour force to work, increasing the participation
in the economy. The major benefit behind this can be seen in the Solow Growth Model,
which suggests that sustainable economic growth can only be reached by (1) and increase in
the size of the labour force, or (2) increasing productivity. With UK productivity growth
stalling, it would seem logical that the government seek to increase the participation rate to
support economic growth.

Finally, the chapter considers collective bargaining, and the development of labour unions.
For the worker, a labour union is beneficial as it allows for workers to bargain their benefits
on a larger scale, giving them more power when it comes to negotiations. However, to
businesses, labour unions can represent a barrier, restricting activities and adding to costs.
Given this, it could be imagined that governments who prefer a free market about to labour-
markets will seek to reduce the power of labour unions.

1.9 References & Bibliography

Sloane, P., Latreille, P., & O’Leary, N. (2013). Modern Labour Economics, London,
Routledge.

Sloman, J., Norris, K., & Garrett, D. (2013). Principles of economics, London, Pearson
Higher Education.