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Course Introduction

Hello Dear distance learner! How have you been doing? I hope you have enjoyed
your study of the courses that have taken. As you know in other economics
courses, labour is of the most important factors of production. Hence manpower
Economics deals with the study of the workings and outcomes of the labor
market. Manpower economics is one of the most relevant and interesting parts
of economics courses. A good grasp of manpower economics is vital for
designing and understanding manpower policies and for Manpower Planning
and more generally for appreciating how a modern economy functions.

The fundamental objectives of this course is again to introduce students of

Economics with the over all policies of labour and labour market and related
Specifically the course deals with
v Labor Supply theory such as Measurement and the labor force
participation, the Labor Supply Curve, Elasticity of Labor Supply etc.
v Labor demand such as the Short-run demand for labor, the demand for
labor in the long run and elasticity of labor demand.
v Labor markets and wage determination.
v Manpower planning and labour policy.

This course has eight parts. The introductory part is covered in the first part .
The second part deals with labor supply theory, the third part states about labour
demand, the fourth part discusses about wage determination, the fifth and sixth
part of this course deals with labour market and manpower planning
respectively, the seventh part deal with labour policy and the last part discusses
about employment Problems of LDCs

Labor economics is simply defined as the study of the workings and outcomes
of the labor market. The workers offer their services to firms in the labor market
where both the pecuniary and non-pecuniary factors play significant role in the
transactions. How do both the employers and employees behave to the changes
in pecuniary (wages, prices & profits) and non-pecuniary (working conditions,
risk of injury, personalities of managers and flexibility of working hours) aspects
of employment relationships? Labor economics tries to deal with such
behaviors of the agents in the labor market that is whether such incentives
motivate or limit the agents’ choice.

Three agents can be identified in the labor market: workers, firms and the
government. All these actors of the labor market follow their own objectives.
With the objective of achieving utility maximization, workers need to decide
whether to work or not, how many hours to work, which skills to acquire, which
occupation to enter, whether to join a labor union or not, how much effort to
allocate to the job and when to quit a job. Each of these decisions of all the
workers in the economy constitutes the quantity and quality of labor supplied in
the economy - labor supply curve.

Pursuing the motive of profit maximization, firms need to decide how many and
which types of workers to hire and fire, how much the working hours to be, how
much capital to employ, and whether to offer safe working conditions. Each of
these decisions of all the firms in the economy generates the demand for labor
in aggregate - labor demand curve. However, the motives of workers and firms
are conflicting in the sense that, when the incentives change, the two agents
react differently for such a change. When the wage rate is high, for instance,
workers respond by supplying more of their services while the willingness of
firms to demand labor declines, and vice versa. But such a conflict of interests is
resolved when the labor market reaches an equilibrium point, at which the
demand for labor by firms is exactly equal to the supply of labor by workers.

In reality, however, the labor markets are not left to work by their own. It is widely
believed that economic transactions in the labor market are both voluntary and

mandatory: When both parties gain out of the transaction, the labor market will
facilitate the mutually beneficial transaction. Under such a case the transaction
will be undertaken voluntarily. Although some transactions take place
accordingly, still some other may cause one or more parties to lose and entail
the redistribution of income from the gainers to the losers. The third agent, the
government enters into the labor market so that the re-distributional transaction
will be mandatory. In facilitating the mandatory transactions, the government
can exercise a wide range of policies that include imposing taxes on workers’
earnings, subsidizing the training of workers, setting minimum wage legislating
levying profit tax on firms and encouraging or restricting immigration. In brief
when the economic transactions are mutually advantageous, both parties
participate in the labor market voluntarily. But when the labor market fails to
facilitate mutually beneficial transactions, the compensation of losers must take place
through the intervention of the government.

2.1 Measurement of the Labor force Participation
Being one of the basic indicators of the performance of the economy,
unemployment rate serves as a measure of the extent of the healthiness of the
overall economy. So it is important to give a clear definition of the term
unemployment rate and related concepts. To begin with, part of the population
whose age ranges from 16 years of age can be broadly categorized into the
labor force and out of the labor force groups. The term labor force can further be
divided into employed and unemployed. To be employed a worker must have
been at job with pay for at least are hour, or worked at least 15 hours on a non
paid job such as the family farm. Otherwise, if a worker is actively searching for a
job, or is temporarily laid off and expecting recall but not employed for pay,
he/she is said to be unemployed and constitutes the labor force. If a person is
neither employed for pay not actively looking for a job and is permanently laid
off, he/she is said to be out of the labor force.

It is however, important to note that there are sizeable flows of workers between
groups. We can identify four major flows of people between groups:
1. From the employed to unemployed groups: - some workers may be
voluntarily quitting or laid off
2. From the unemployed to the employed groups: - some unemployed
workers may be newly hired or recalled from temporary laid off
3. From the labor force to out of the labor force: - some employed or
unemployed workers may retire or drop out of work
4. From out of the labor force to the labor force (new graduates, for
example) and some of the drop outs may reenter the labor force

The labor force participation (LF) is measured by adding up the number of

workers being employed (E) and unemployed (U). If we divide the size of the
labor force to the entire population, we arrive at the fraction of the population
that is in the labor force, the labor force participation rate.

Labor force participation rate =

The labor force participation rate can be decomposed by sex and the trends can
be compared between the two sex groups. For economic analysis purpose we
can go further and identify two measures: employment rate and unemployment
rate. Employment rate is given as a fraction of the population being employed

Employment rate =

While unemployment rate is taken as a fraction of the labor force being

Employment rate =

Some economists have preferred to use employment rate rather than

unemployment rate to measure the aggregate economic activity arguing that the
rate indicates the fraction of the population at a jog. In spite of the argument,
using employment rate as a measure of economic activity has the shortcoming
of excluding the potential, but unemployed, workers from the economic activities
by regarding them like out of the labor force. The most widely used measure of
the labor market and, thus the economic activity is the unemployment rate. The
lower (higher) the unemployment rate, the easier (more difficult) to find jobs for
the unemployed and the larger (smeller) the tightness of the labor market. In
short, the unemployment rate and its growth rate over time fairly measure the
stability of the labor market and the economic activity in general.
2.2. The Work-Leisure Decision Model
Of the 24-hours a day available to us if we allocate 8 hours for biologically and
culturally determined activities like sleeping, eating and others, the remaining 16
hours will be at our disposal. We can spend them either for work or for leisure, or
some combinations them. To analyze the workers’ behavior in allocating the
discretionary hours between work and leisure, economist employ the
neoclassical work-leisure decision model. Having the goal of identifying the
factors that determine whether to work at all and, if so, how long to work, the
model not only helps us understand the facts about labor supply but also
enables us predict the influence of complex policy issues on the labor supply
behavior. The model regards workers as having the objective of utility
maximization in which preferences of a worker and budget constraints are key

(a) Preferences of a worker

A worker, as a consumer, generates satisfaction out of the consumption of a

wide range of commodities and leisure. For the sake of simplicity, the total dollar
value spent on purchasing various commodities is regarded as the total value of
all the goods consumed to derive the requisite satisfaction. To depict
preferences of workers in a two-dimensional space, we need to decompose the
sources of satisfaction in to two groups: money income, C, the total dollar value
of all the commodities consumed (it is assumed that the worker uses all his
income for consumption, there is no saving), and leisure, L, the number of hours
spent for leisure. So the utility function is

Where U is the level of utility derived; C is the money income and L is the leisure
time. Both C and L are goods’ not bads’ in the sense that the larger the money
income given the price of commodities and/or the larger the leisure time, the
higher the level of utility will be. These two goods, C and L, are to some extent
substitutes for each other. This means that various combinations of C and L
yield the same level of satisfaction - if a worker were made to forgo some hours
of leisure for work, he/she would enjoy an increment on his money income so
that his/her satisfaction could keep unchanged. The locus of points that stand
for equal utility is termed as an indifference curve. If however, the rise in either of
the arguments leads to an increment in the utility level or both a arguments rise,
the new basket of C and L will yield a higher level of satisfaction that puts the
consumer on a higher indifference curve.

Money wage

C1 x

C3 z

C2 y utility level A
Utility level B

L1 L2 L3 Hours of leisure
Figure 2.1. The indifference curves of an individual
Indifference curves have the following I portent characteristics;

1. Higher indifference curves represent higher levels of utility: every point on
the Utility level B yields a higher-level satisfaction than and is preferred to
the baskets in utility level A. So any indifference curve that lies to the
northeast of another one is preferred to any curve to the southwest.
2. Indifference curves are downward sloping: as both leisure and money
income are goods, for an individual to keep utility constant either leisure
or money income should increase as the other decrease. The slope of the
indifference curves are steep (flat) at the upper left (lower right) segment,
implying that the person is not willing to increase the leisure hours by
large amount for a given reduction in money income to hold utility
constant. The flatter (steeper) the indifference curve, the lower (higher)
value the individual places on an additional hour of leisure in order to keep
utility constant.
3. Indifference curves do not intersect: If they did, the point of intersection
would represent a combination C and L that yield different level of
4. Indifference carves are convex: the curves are steeper at the left and
flatter at the right only reflecting that when money income is relatively
high and leisure hours are relatively few, leisure is more highly valued and
expensive than when money income is relatively low and leisure hours are
relatively large.

The slope of the Indifference curves

The slope of the indifference curve represents the effect on the worker’s utility
when she/he moves along a given indifference curve. Since both C and L are
goods, if we devote more hours for leisure holding constant money income, the
marginal utility of leisure contributes positively to the individual’s utility. So does
the marginal utility of money income, if we devote more hours for work holding
constant leisure. However a movement along the indifference curve, say from
points Y to point X in figure 2.1, is leading to reduce utility by the product of the
number of leisure hours being given up, and the associated loss of marginal
utility, The worker place the forgone leisure hours on work and earn
additional money income to be used for consumption. A similar movement,
hence, increases the utility of the individual by the product of the additional
amount of money income earned by devoting more hours on work. , and
the additional utility derived out of the consumption of goods purchased by
using the additional money income Since the movement along the
indifference curve involves no charge in total utility, the loss is exactly
compensated by the gain

Money wage, C

Upon rearranging,
+C (2.2) can be written as

The absolute value of equation (2.3) represents the slope of the indifference
curve, which is also called the marginal rate of substitution in consumption.

(b) The Budget Constraint

If the resources were not scarce, every worker would like to enjoy the ideally
highest indifference curve. But the discretionary hours are limited that the
number of hours available
V for leisure and work, and hence E the resulting amount
of money income are limited. Therefore, the indifference curve the worker can
attain is constrained by the limitations of resources.
The resource that is Ounder the command of the workerT is constituted Hours offrom
work the
money income and leisure
Figure 2.2 thetime.
budgetThe money
constraint lineincome may be obtained from
for a worker
various sources including non-labor income (property income, dividends and
lottery prices) and labor income that constitute the person’s budget constraint

Where w is the hourly wage rate of which value is constant regardless of the
number of hours worked and V stands for the non-labor income. The
discretionary total time, T, can be allocated into different combinations of leisure
and work so that

Where L is the number of hours allocated for leisure time. Thus equations (2.4)
and (2.5) give the budget constraint equation of

From this budget line, we can derive the ratio of the increment on money income
to the increment in the number of hours spent on leisure . The absolute
value of this ratio is the slope of the budget constraint, wage rate.
Figure 2.2 indicates that the worker has various alternatives on how to allocate
his discretionary time. If he prefers to spend the total time, T, for leisure, he/she
works zero hours and makes use of V amounts of non labor income only to
purchase commodities, In stead if the worker chooses to spend the total time, T,
working, he/she will have zero hours for leisure and his/her command over
commodities will become (wT+V) amounts. Any combination of leisure and
money income that lie to the right of this budget constraint cannot be attained by
the person.

Given the budget constraint line, how does the worker maximize utility? Since the
set of leisure and money income above the budget line are not affordable, they
must be excluded from the possible level of the utility index. To make matters
simple, let’s take the following example of hypothetical workers. The worker has
a non-labor income of Birr 10 per day, faces a constant market wage rate of Birr
10 per hour, and has 16 hours of discretionary time per day. This means that the
person could use only his non-labor income of Birr 10 to purchase commodities
if he preferred to allocate all 16 hours for leisure. The money income leisure
combination of such a choice is given at point E of Figure 2.3 below. It is also
possible for the worker to allocate the total time for work, of which decision is
located at point F of Figure 2.3, the intercept of the budget constraint line, the
total money income of which is Birr 170. Otherwise, the combination of leisure
and money income would lie between these two extreme points.

Money wage

Birr 170 F

Birr 140 B D

Birr 90 A

Birr 10 E

0 3 8 16 Hours of leisure
16 13 8 0 Hours of work
Figure 2.3: The Indifference curves and the budget constraint line of a worker
Since the level of the utility index U, cannot be affordable for the worker, he/ she
is bound to make a choice between U* and Uo preferences. This is because under
Birr 10 per hour labor income and Birr 10 non labor income the worker could
never achieve, for example, the utility level point D, which could only be afforded
by purchasing Birr 140 worth of commodities while working only 8 hours. The
worker can choose any combinations of utility level Uo, particularly those points
between A and C. But he/she would not prefer these combinations because they
yield less utility than that can be obtained from the level of the utility index U*. So
the highest possible utility level attainable to the worker, working 8-hours per day
and earning a daily money income of Birr 90, is given by point A. So the
indifference curve that is just tangent to the budget constraint line gives the
maximum possible utility level. A movement away from this point along the
budget constraint would yield a lower level of utility.

In connection with this, we can say that workers with the same budget constraint
line but with different preferences for leisure will have different choices for work,
and thus the point of tangency will be located either to the right or to the left of
point A. If the preference curve of a worker was (flatter) signifying that leisure
time was (working hours were) more valuable, the tangency point would be to
the right (left) of point A. When the tangency point inside the corner points, i.e.
between point E and F, neither included, the solution is said to be an interior
solution. But some people’s preferences for leisure is so strong that their

indifference curve is quite steep, in other words utility is maximized at the
corner (point E), signifying that these people choose not to work at all. Under
such a condition the solution is said to be a corner solution.

At the tangency point, the slope of the indifference curve is equal to the slope of
the budget constraint line. Mathematically, this equality is given by

The marginal rate of substitution, , is the rate at which the worker is willing

to give up leisure hours in exchange for additional consumption; and the market
wage rate, W, is the rate at which the market is willing to let the worker substitute
one hours of leisure for consumption.
Equation (2.6) can be rewritten as

Where measures the additional utility obtained from consuming an

additional hours of leisure. The ratio of these two variables measures the
number of units received by spending on additional money income (Birr) on
leisure. Since measurers the additional utility received by spending an
additional money income (Birr) on consumption goods, equation (2.6) states that
the last Birr spent on leisure activities buys the same amount of units as the last
Birr spent on consumption goods.

The Effect of Changes in the Non labor and Labor Incomes

(a) The Effect of Nan labor Income
To see what will happen to the labor supply decision of a worker when the
non-labor income increases; let us assume that the market wage rate is
maintained to be constant. I our hypothetical worker’s non labor income
increases from Birr 10 to Birr 50 on account of receiving a dividend payment,
then the workers money income will equal to Birr 50 plus his/her earnings out of
work (= the number of hours worked X the market wage rate of Birr 10 per hour).
Consequently, the new budget line will shift upward parallel to the previous one.

Money wage

Birr 210 F1

Birr 170 F0

U 1*

U 0*
Birr 50 E1

Birr 10 E0

Figure 2.4: The Indifference curves and budget constraint lines with the
change in the
labor income
Since the market wage rate doesn’t change, the slope of the budget constraint
line remains the same. However after the rise in the non-labor income the worker
can afford the higher indifference curve U1*there by becoming better off. The
new optimal point, point G, indicates that both expenditures on consumption
goods and the number of hours spent for leisure has increased. Now, at point G,
the worker spends only 6 hours of working. This implies that leisure is a normal
good. If leisure becomes an inferior good, when the non-labor income increased,
the number of hours spent on working also increased, and the optimal point
would be located to the left of point A. Thus we can exclude the second
alternative by assuming that leisure is a normal good.

In short, the income effect, the impact of non-labor income on the number of
hours worked, implies that an increase in non-labor income holding the wage
rate constant reduces the hours of work.

(b) The effect of Labor Income
Holding non-labor income constant, if the market wage rate were to be increased
from Birr 10 to Birr 20 per hour, such a rise in the labor income would give rise
to both an income and substitution effect. Workers would become wealthier than
before and be pushed to spend more hours on leisure. This income effect would
reduce the number of hours worked. In contrast, the opportunity cost of leisure,
the market wage rate, would be so high that the worker would be pushed to work
more hours-substitution effect. Whether the effect of market wage rate on
leisure time is positive or negative depends on the net effect of income and
substitution effects.
Money wage money wage

F F U 2/
A U2 A/ U 1/

E E/

0 8 10 16 leisure 0 6 8 16 leisure
16 8 6 0 work 16 10 8 0 work

(a) Substitution effect dominating (b) Income effect dominating

Under both panel (a) the income effect is stronger than the income effect there
upon reducing the number of hours worked. In this panel as the market wage
rate increases from Birr 10 to Birr 20 per hour, the worker attains the higher level
of utility, U2, and the number of hours worked falls from 3 hours to 6 hours. This
is because of the fact that an increase in income raises the demand for all
normal goods, including leisure.

In panel (b) of the bore diagram the substitution affect dominates the income
effect as a result the number of working hours increased. As the market wage
rate rises from 10 Birr to 20 Birr per hours, the worker can offer the utility level,
U2, the tangency point of which suggests that 10 hours of working is optimum.
This is because of the fact that leisure becomes so expensive (the opportunity
cost of leisure time has increased to Birr 20 per hour) that high-wage workers
have strong incentives to cut back on their consumption of leisure activities.

Consequently, the substitution effect of a rise in the market wage rate makes the
demand for leisure fall and hours of work rise.

Isolating Income and Substitution Effects

When the market wage rate rises from Birr 10 to Birr 20, both panels of Figure
2.5 have indicated that the worker has attained the higher utility level as the
budget line rotates in a clockwise direction. For instructive purpose, such a move
from the old to the new optimal bundle resulting from a market wage change can
be decomposed into income effect and substitution effect. The illustration
proceeds with considering the response of the working hours to the wage
change in panel (a) of Figure 2.5, signifying that substitution effect dominates.

As the income effect refers to the change in the desired hours of work resulting
from a change in wealth (non labor income) keeping the wage rate constant, the
first stage move from point A to J in Fig. 2.6 can depict the income effect.

Money wage money wage

J U2 J

F A U1


0 8 12 16 leisure 0 10 12 16 leisure
16 8 4 0 work 16 6 4 0 work

(a) Income effect (b) Substitution effect

Figure 2.6: Decomposing the income and substitution effects

Note that the movement from point A to point J must reduce the number of
hours worked from 8 hours per day to 4 hours per day because leisure is a
normal good. If the non-labor income increased holding wage cons4tant, the
budget constraint line would shift up parallel to the previous one and the impact
of non labor income change on income would be negative. This means the new

utility maximizing point, point J, should be located to the northeast of the old one
point A.

The next task will be to isolate the substitution effect, which depicts the
response to the utility maximizing point when the market wage rate changes,
holding the utility level, U2, constant. Panel (b) of Fig. 2.6 should the movement
along the same indifference curve, U2, representing a fixed utility level or real
income, leads to an increment in the number of hours worked from 4 hours per
day to 6 hours per day. As the wage rises, the number of hours allocated for
leisure activities decline. The substitution effect, therefore, implies that an
increase in the wage rate, holding real income constant, increases hours of work.
Comparing the income and substitution effects indicates that the income effect
tends to reduce the hours of work by 4 hours per day while the substitution effect
indicates that the income effect tends to increase the hours of work by 2 hours
per day. This results in a net effect of 2 more hours of leisure each day. In short,
the income effect dominates the substitution effect, leading to have a negative
relationship between the hours of work and the wage rate.

The Reservation Wage

Before people decide how many hours to allocate for work, they need to make a
decision of joining the labor force, deciding to work or not to work, in the first
place. Actually, a worker places a value on the marginal hour of leisure time. If
the offered wage rate is greater than this value, the worker will be willing to enter
the labor force. If the market wage rate falls below the value placed on the lost
leisure time, the person will not be motivated to work. Therefore, the market
wage at which the worker becomes indifferent between taking a job or not is
referred to as the reservation wage.

Money wage
If the market wage rate is Birr 10 per hour, the budget constraint line will be given
by line G Figure 2.7. At this wage rate, the worker is made to prefer a utility
EF in
level cover than U1, like point A. In contract, if the wage rate rose to Birr 20 per
day the worker would face the budget line EG, and the optimal point would be
given by point B at the indifference curve U2. At point E on the indifference curve
of U1 the worker maximizes utility by spending all the discretionary hours on
leisure activities.

The illustration depicts that the worker will be willing to offer his service if the
wage 170isFBirr 20 per hour and choosing not to take a job if it is Birr 8 per hour.
As the budget line rotates from EF to EG, the worker faces a budget line, the
wage rate of which makes him/her indifferentB between working and not working.
That specific wage rate constitutesA the reservation wage. The reservation wage
gives 10 minimum increase in income thatEwould make the U2 person indifferent
between remaining at point E and working that extra hour.U1
Some implications of the reservation wage: U0
1. The decision to take a job is made by comparing the reservationHours of workand
the0market wage. If the market wage 16 is greater (less) than the marginal
value of leisure time, the worker will (will not) participate in the labor
2. Since the reservation wage depends on the person’s taste for work, as the
worker’s non labor income increases, his/her reservation wage becomes

higher and consequently the person is less likely to enter the labor force
3. Suppose the market wage rate increases holding the reservation wage
constant the worker who faces the higher market wage is more likely to
participate in the labor market. Therefore, there is a positive relation
between the market wage and the probability of working.

2.3 The Labor Supply Curve

The preceding explanation states that the reservation wage constitutes the
starting point for every workers labor supply decision, i.e. for the worker to
participate in the labor market the prevailing market wage must be greater than
the reservation wage. Once the market wage stars to increase above the
reservation wage the worker starts to allocate more and more hours of work.
Such a relation between the market wage rate and the number of hours allocated
for work provides the labor supply curve.

Wage Rate (Birr)

Fig. 2.8 Labor supply Curve

As figure 2.8 depicts, when the market wage rate is below the reservation wage
rate, WR, the hours of work is zero. When the wage rate rises above the
reservation wage rate the worker starts to put more hours on work. However the
shape of the labor supply curve above WR wage rate depends on the net effect of

income and substitution. When the substitution effect dominates the income
affect, the labor supply curve is positively slopped because the wage rate up until

makes leisure more expensive than it makes the person wealthier. But the

increase in the market wage beyond leads to a fall in the hours of work as the
income effect stats to dominate the substitution effect, signifying a negatively
sloped labor supply curve. The segment of labor supply curve depicted by the
negative slope is termed as back-word bending labor supply curve.

The market labor supply curve for the economy as a whole can be generated by
horizontally adding the hours of work by ever individual for a given market wage

Wage Rate Wage Rate Wage Rate


Fig 2.9: The labor supply curves for two persons, A and B, and the market labor
supply curve
The above figure indicates that LAss and LBss stands for the labor supply curves for
individual A and B, and WRA and WRB stand for their respective reservation wages.
The market labor supply is zero if the market wage rate is below WRA, is the same

as the labor supply of individual A if the market wage rate lies between WRA and
WRB, and is the sum of the labor supply of the two individuals if it exceeds WRA.

2.4. Elasticity of Labor Supply

The elasticity of labor supply measures the extent of responsiveness of hours of
work to changes in the wage rate.

where h and w represents hours of work and wage rate respectively. The sign of
the labor supply elasticity depends on the slope of the labor supply curve. When
the labor supply curve is positively sloped, i.e. when substitution effect
dominates the income effect, the labor supply elasticity is positive. In contrast,
when the labor supply curve is backward bending, i.e. when the income effect
dominates the substitution effect, the labor supply elasticity bears a negative
value. Apart from the variation in sign, the labor supply elasticity may vary in
magnitude sometimes may exceed a value of one. In the forms case the hours of
work are less responsive, or inelastic, to the given change in the money wage
rate while in the latter case the coefficient is said to be elastic.

2.5 Extensions of the Neo-classical labor-Leisure choice Model

The neoclassical labor supply model, sometimes referred to as the static labor
supply model, only deals with whither a worker decides to participate in the labor
market or not, if so, how many hours to work at a given point in time. Although
such a model helps us understand the unship between economic variables, a
more profound model that takes into account the labor supply decisions over the
life cycle of a worker and over the business cycle, the factors that determine
whether and when to retire, and the labor supply decisions of the hours hold
members is very essential. The static labor leisure choice model is extended to
incorporate the following four points.

(1) Labor supply over the life Cycle

Workers make economic decisions of whether to work or not and how many
hours to work not only in a single time period but also over many years. Today’s
decision whether to work or not influence the economic opportunities in the
future and are obviously influenced by the decisions made in the past. If for
example, we choose to work more and allocate less time for leisure activities
today, we will earn more money income and enjoy more consumption in the
A lot of empirical evidences support that wage the earnings of a representative
worker vary over his entire working life. At early stages as a worker, when the
person is young, the worker’s wage earning is low; when the worker’s age
increases so does his/her earnings, reaches its peak at about the age of 50 and
becomes stable or decline thereafter. The variation in the wage earnings of a
typical worker per time is called andevolutionary’ wage change.

It is important to note that the typical worker expects that the market wage
he/she faces is low when the person is young, goes up us he/she gets older and
older and goes as he/she gets nearer to the retirement are. Since an evolutionary
wage change over time has already been expected, any change in the market
wage from age to age does not result in an increase in the worker’s total lifetime
wealth. It therefore, follows that in order to make an optimal decision worker
needs to spend more hours of work when the wage rate is high, and to choose
more leisure activities when the wage rate is low.

Two important links between economic variables can be identified in the life
cycle approach. Firstly, the hours of work and the wage rate move together over
time for a particular worker. Since an evolutionary wage change doesn’t bring in
an increase in the total lifetime income, the opportunity set remains to be so
intact that the change doesn’t generate an income effect. Secondly, a
relationship can also be established between wages and the labor force
participation rates. As the participation decision takes into account the
comparison of reservation wage, to the market wage rate, every time in the life
cycle the worker is likely to enter or remain in the labor force as long as the
market wage rate is high enough. As a result the participation rate is likely to be
low for young and old workers and high for prime-age workers.

(2) Labor Supply over the Business Cycle

When there is a change in the business cycle, workers try to adjust their labor
supply in response to the economic fluctuations. The relationship between the
business cycle and the labor force participation rate can be grouped into the
added worker effect and the discouraged workers effect.

The main breadwinner may become unemployed or face a wage cut when a
recession occurs in the economy. In order to maintain the previous utility level of
the family, secondary workers (young persons or mothers with small children)
should search for jobs the income form, which could make up the loss. So this
member of the household will become an added member of the labor force. The

added worker effect thus implies that the labor force participation rate of
secondary workers has a countercyclical trend; it rises during recession and
declines during expansions.

During a recession period the chance of finding jobs is almost impossible and
the excess supply of labor reduces the real wages for those who are already
employed. Those who are already unemployed and looking for jobs give up. They
become discouraged and remain out of the labor force. This discouraged worker
effect results in a pro-cyclical trend in the labor force participation rate: it falls
during recessions and increases during expansions.

(3) Household Production

Apart from allocating the discretionary time for leisure activities and work, in the
labor market, workers put part of their time for the production of a variety of
commodities in the household or in the non-market sector. The allocation of
time for household production, however, varies according to the marital status
and sex differences. As women tend to devote much time in the household
production, they allocate fewer hours to the market sector than men. Married
women tend to devote fewer hours to the labor market than single women. In
spite of being seldom available in the market and yielding lower earnings, the
hours allocated for the household sector makes the family better off.

Differences in the market wage among household members leads to differences

in the allocation of work within the household. A member facing high market
wage should better participate in the labor market than a member facing low
wage rate for the opportunity set of the household to expand. It is worth noting
that an increase in the market wage will induce the family member facing high
wage to increase the time allocated in the labor market. Similarly, an increase in
productivity in the household sector will induce the family member facing low
market wage to devote more time in the household sector. The model does
predict, therefore, that the family member with the lower wage or with a greater
productivity in the household sector is the member who will likely specialize in
the household production.
(4) Fertility
The long run labor supply is determined by the fertility decision of households.
The household’s fertility in turn depends on incomes and prices. To decide the
number of children a household should have, it needs to take into account the
income of the household and the quantity of goods it consumes. This is because
of the fact that children are extremely expensive commodity. Child raising
activities involve not only direct costs, including food, shelter, clothing and

education, but also the foregone earnings, including the time spent on taking
care of them.

If the household’s income increases, the opportunity set will expand and hence
the household’s willingness to have more children will increase, as children are
regarded as normal goods. Therefore there is a positive correlation between
income of the household and fertility. However if prices increase, this will make
the cost of having children so expensive that the household wishes to have
fewer numbers of children. So, there is a negative correlation between prices of
having children and fertility. The fertility of the population, and hence the long-run
labor supply, falls as real income and wages, resulting from the economic
growth process, increases.

The labor market analysis becomes complete when the agents that constitute
demand side are dealt with. The agents are firms who make decisions of hiring
and firing of workers. In order to satisfy the consumers demand for goods and
services, firms engage in the production process of those goods and services.
The production of such goods and services gives rise to the demand for labor
and other factors of production like and, building, capital and machines. The
demand for labor is therefore, derived from the consumers’ demand for goods
and services. Consequently, the firm’s labor demand is a derived demand.

Unlike the demand for the other factors of production, the demand for labor is
given a special consideration in economies. Of the social, political and economic
considerations, labor economics emphasizes on the economic policies that are
said to facilitate the functioning of the labor market. This unit is organized in
such a way that the demand for labor in the short-and long run will be discussed
together with how the elasticity coefficients of labor demand and factor
substitutions are measured. To simplify the understanding of these concepts,
the discussion starts with the explanation and specification of the production

3.1. The Production Function

The production function describes the technological relationships between
inputs and outputs. For the sales of simplicity, the inputs are categorized into
two groups: labor and capital. The economic variable labor is measured by the
number of hours hired by firms and that of capital includes the other factors of
production except labor. Thus the production function can be written as

Where Q is the firm's output, L is the amount of employee-hours employed by the

employer and K is the physical unit of capital used in the production process. It
is important to note first, that L is obtained by multiplying the number of workers
hired by the average number of hours worked per person. Second, the workers
skill is assumed to be homogeneous so that different workers are aggregated
into the single variable labor.

Marginal and Average Products

From the production function of which specification is given by equation (3.1) we
can produce two important concepts: Marginal Products and Average Products.
As the inputs are categorized into two groups, we can identify two marginal
products the marginal product of labor and the marginal product of capital.
Formally the marginal product of labor (MP) is simply defined as the change in
physical output (∆Q) produced by hiring an additional unit of labor (∆L) holding
capital constant

Similarly, The marginal product of capital is defined as the change in output

resulting form a one-unit change in the capital stock , holding labor constant

Graphically, the marginal product curves are derived from the total product curve

as the firm hires more workers. Figure 3.1 (a) illustrates the total product curve,
which is upward sloping. Figure 3.1(b) depicts the marginal and average product
curves. The marginal product curve is the slope of the total product curve, i.e. the
rate of change in output as more workers are hired.

Output output

Total Product


Marginal Product

(a) Number of workers (b) Number of workers

It rises initially but eventually starts to decrease as more workers are hired. Since
the marginal product of labor is measured by holding capital constant the
increment on output as more workers employed must be subject to the law of
diminishing returns.

The average product of labor is defined as amount of output produced per


From figure 4.1(b) we can establish the following relationship: the MPL curve lies
above the MPL curve when the latter is rising, and the APL curve lies below the
APL curve when the latter is falling. It implies that the MPL curve intersects the
APL curve at the point where APL curve peaks.

Marginal Revenue Product

Usually firms make production decisions by considering what is prevailing in the

output market rather than the availability of factors of production. Employment
depends on the revenue generated by producing and selling extra output in the
market. The more important concept associated with the production decision of
firms is that of the marginal Revenue Product or the value of marginal Product. It
is defined as the money value generated from hiving an additional worker.

Where VMPL is the value of marginal product of labor and MR is the marginal
revenue. The marginal revenue that is generated by an extra output sold depends
on the bind of market in which the product is sold. If the market is a perfectly
competitive, then the marginal revenue is identical to the product price (P) and
equation (3.5) can written as

Likewise, the value of average product of labor is given by the product of the
average product and product price.

3.2. The Short-run demand for labor

The short-run demand for labor analysis focuses on the firms behavior towards
the labor demand over a short period of time during which the capital stock is
hold constant. As a result of this, the law of diminishing marginal returns is
regarded as the critical assumption that lies behind the derivation of the labor
demand curve in the short run. For exposition purpose, the firm works under the
perfectly competitive output market and hires labor from a competitive labor
market so that both the product price and the market wage rate the firm faces
will be constant. Consider the following example, and suppose that the product
price is Birr? And the market wage rate is Birr 22. For the various level of labor
employed the marginal product and the value of marginal product is given as

Value of Value of
No. of Marginal Average
Output Marginal Average
employees product product
Product product
0 - - - - -
1 11 11 11 22 22
2 27 16 13.5 32 27
3 47 20 15.7 40 31.3
4 66 19 16.5 38 33
5 83 17 16.6 34 33.2
6 98 15 16.3 30 32.7
7 111 13 15.9 26 31.7
8 122 11 15.3 22 30.5
9 131 9 14.6 18 29.1


38 w/

22 B w

1 4 8
Number of workers
Figure 3.2: The Firm’s hiring decision in the short run

As depicted in the above diagram, with a wage rate of Birr 22 and product price
of Birr 2, the profit-maximizing firm will choose to hire eight workers. At this level

of employment the curve satisfies two conditions; first, it is downward

sloping, and second, it equals to the wage rate. Note that the wage rate and the
value of marginal product of labor equals at point A and point B. At point A,
however, the value of marginal product of labor curve is upward-sloping and
profit is not maximized because hiring one additional worker would yield extra
revenue for the firm. Unless the law of diminishing returns assumption is
incorporated, the firm would maximize profits by expanding indefinitely. It
implies that the law of diminishing returns is a critical assumption in the
short-run labor demand model.
Suppose the firm decides to hire only six workers. If the firm hired the seventh

worker, the extra revenue obtained by the firm is Birr 26 while the extra cost of
hiring this seventh worker is Birr 22. The positive difference then has an incentive
to employ more labor. In contrast, if the firm were to hire more than eight
workers, the value of marginal product falls short of the wage rate and the firm
will not be motivated to hire additional workers. This implies that a

profit-maximizing firm has to continue to hire workers until

It is important to note that only the level of employment can the firm adjust so

that In other words, the firm, being a competitive, do not have any
influence on the wage and cannot set the wage to the value of marginal product
of labor. If, for instance, the market wage rate is raised to a value of Birr 38, the
firm should adjust its level of employment only to four workers, at which

If the firm hired the fourth worker, however, the (Birr 33)
would be lower than wage rate (Birr 38), and the firm would incur a loss and
leave the market. This implies that the hiring decision for the alternative given
wage rates will take place only if the curve is downward sloping and lies

below the intersection point with the .

The short-run labor demand curve for a firm

This curve indicates how the firm’s employment of labor varies as the wage rate
changes, holding capital constant. From the preceding discussion, we know that
the demand for labor curve is constituted from the portion of the value of
marginal product of labor curve that is down-ward sloping and lies below the
point where the VMPLcurve intersect the VMPL curve.


Birr 22 w/

Birr 18 w


No. of workers
Figure 3.3: The short run demand curve for labor
When the wage rate is Birr 22, the firm hires eight workers, when falls to Birr 18,
the form hires nine workers. The short-run demand curve for labor, therefore, is
given by the value of marginal product curve. Because the value of marginal
product of labor declines as more workers are hired, it must be the case that a
fall in the wage increases the demand for labor.

The demand for labor curve is also affected by the change in output price. The
short run labor demand curve shifts upward for the given wage rate if the price of
output increases. In fig. 4.3 for the given wage of Birr 22, suppose that the output
price increases, which shifts the outward to . Then the firm’s
demand for labor will increase from 8 to 12 workers. Therefore, there is a
positive relationship between short-run labor demand and product price. In
addition to the output price, productive efficiency of workers, which improve the
marginal product of labor employed, also affects the demand for labor curves
my shifting it upward.

The short-run labor demand curve in the industry

Once the sort-run labor demand curve for a firm is derived, it would apparently
seem easy to derive for the industry, by taking the horizontal summation of the
individual firm’s labor demand curve. Such a derivation of the industry’s labor
demand curve is misleading because it takes no account of the possible change
in the output price of the industry when total output of the industry increases.
When the wage rate decreases every firm in the industry will increase its level of
employment that will lead to a great deal of output in the industry for the given

demand. This excess supply of output eventually causes the output price to fall,
and hence the value of marginal product of labor, the product of and P, to
fall. Consequently, at the lower wage rate, the labor demand curve of each firm
will shift slightly to the left.

Wage D T

20 20

10 30 56 60 emp

15 28 30 T D

(a) Individual firms (b) Industry
Fig 3.4: The Industry’s labor demand curve

Each firm in the industry initially hires 15 workers when the wage rate is Birr 20.
Then the total employment in the industry will be 30 if there are only two firms in
the industry. But if the wage falls to Birr 10, each firm tends to hire 30 workers.
The resulting total employment in the industry would have been 60 had the labor
demand in the industry been the horizontal summation of the two firms’ demand
for labor. And the demand for labor curve in the industry would have been given
by the curve DD in Fig 3.4(b).
Following the fall in wage from Birr 20 to Birr 10, however, firms in the industry
will expand output thereby reducing the price of output and the value of marginal
product. Consequently, the total employment in the industry will be 56 instead of
60, as the labor demand curve for the industry becomes steeper. The true’
industry labor demand curve is given by TT.

The Marginal Approach
The hiring decisions of firms could be alternatively reached by employing the
marginal productivity conditions. According to this alternative method the
profit-maximization level of employment is identified by equating the marginal
cost with the marginal revenue-the additional cost of producing an additional
unit of output must be equal to the extra revenue obtained from selling that

3.3 The Demand for labor in the Long Run

The short-run labor demand discussion assumes that the time period is so short
that the level of capital stock remains fixed. In this section we will see what
happens to the demand for labor if the time period is long enough that the level
of capital changes- the plant size can expand or contract. Therefore, the long run
profit-maximization condition requires making decisions about the number
workers to be employed and the amount of plant and equipment to invest in. The
explanation of this section starts by emphasizing the basic microeconomic
concepts of cost minimization.

Concepts of Cost Minimization

Isoquants and isocosts underlie the cost minimization concept. An isoquant is
the possible combinations of capital and labor that produce the same level of
Out put.

Capital capital

c1//r C1


B Q1 C0


(L labor employment. c0/r

(a) Isoquant curves (b) Isocost curves
Properties of isoquant curves
- Isoquants must be downwards sloping
- Isoquants do not intersect
- Higher isoquants, Q1 , are associated with higher levels of output
- Isoquants are convex to the origin
The slope of an isoquant is given by the negative of the ratio of marginal products. In Fig
4.5(a), the movement from point A to point B, the firm hires additional labor, each
producing units of output. Hence the total output gained out of the employment

of units of labor is given by the product The same movement along

the Q0 curve makes the firm reduce unite of capital, each reducing the total output
by . Hence the total loss in output as a result of this reduction is given by the

product . But the movement from point A to point B leaves total output

unaffected so that

The absolute value of the slope of an isoquant yields the marginal rate or technical
substitution. The convexity assumption of an isoquant implies diminishing marginal rate
of technical substitution as the firm substitutes more labor for capital.

An isocost is the various combinations of labor and capital that the firm could hire so
that the cost outlay is the same. It has the property that the higher isocost line C1

represents the higher cost of production. The slope of the isocost line is derived from
the firm’s cost of production function given by
C = WL + K. ………………………(3.8)
Where C is the total cost outlay, r is the price of capital. By rearranging terms in equation

Equation (3.9), the slope of the isocost line, is the negative of the ratio of input prices,
cost- minimization principle dictates that the firm, in order to maximize profit by
producing Q0 level of output, should produce this output at the lowest possible cost. In
order to produce Q0 level of output the firm can use different combinations of labor and
capital .


K1 B

K0 A

K2 C Q0

L1 L0 L2 c0/w c1/w
However the least possible cost of producing Qo is given at point A, where the firm hires
Lo and Ko units of inputs. Whereas, capital-labor combinations given by points B and C
produce Qo level of output at a higher cost outlay, C1,. The firm minimizes costs when it
uses the capital labor combination at which the iscost is tangent to the asquint curve,

implying that the slope of the is cost line equals to the slope of the asquint

curve . At optimal combination of capital and labor the marginal rate

of technical substitution equals the ratio of input prices. Upon rearranging the equality

gives the output yield of the last Birr spent labor. This is because the ratio

of the output produced by the last worker, MPL, to the cost spent on the last worker, w.

Likewise gives the output yield of the last Birr spent on capital.
Cost-minimization implies that the last Birr spent on labor yield and that on capital must
be equal.

In addition to cost-minimization, we need to consider the profit maximizing behavior of

the firm since the two concepts are different. Cost minimization constrains the firm to
concentrate on the given level of output, Qo, rather than considering the other options
for profit-maximization. Profit-maximization condition, however, enables the form to
choose the optimal level of output, by comparing the marginal cost and marginal
revenue for different possible set of outputs. There fore the long run
profit-maximization condition requires that labor and capital are hired until

Note that profit maximization implies cost minimization.


Equation (3.12) is the condition for cost- minimization. However, cost-minimization

need not imply profit-maximization.
The Long-run Demand Curve for Labor
The long-run Labor demand curve graphs the relationship between the long-run demand
for labor and wage rate. To see what the labor demand curve looks like where the wage
rate change let us consider that
§ The firm is initially producing Qo units of output
§ The corresponding input prices are Wo and ro
§ Qo satisfies both profit-maximizing and cost minimizing conditions
§ The optimal cost outlay associated with Qo level of output is given by Co

Suppose the market wage falls from Wo to W1. The slope of the isocost line becomes
small and the isocost line becomes flatter than before. Unless the firm’s total outlay, Co
remains the same, the new isocost line doesn’t rotate around the original intercept, co/r.
However, the firm’s cost outlay need not be the same before and after the change in
wage. Instead of originating from the initial intercept, the new isocost line may start
from an intercept, which is located over the previous one. Another important result that
follows from the wage cut is the fall in the marginal cost of producing the firm’s output.
An additional unit of output can be produced when labor becomes cheap. The upward
sloping marginal cost curve will shift rightward following this wage cut. At the given
output price, which is equal to the marginal revenue for competitive firm, the
profit-maximizing level of output, occurs at a higher level of output. After the wage cut
the Marginal cost
Birr K

MC0 c1/r

P Q1


Q0 Q1 L0 L1 c0/w0 c1/w1
Fig. 3-7 The Impact of wage reduction on output and employment of a
profit-maximizing firm
Shifts from MCo to MC1 and the new MC curve equates with the output with the output
price at Q level of output so that profit is maximiz3ed after the fall. Then the firm
decides to produce Q1 level of output.
Figure 3-7(b) illustrates that the new isoquuant curve, Q1 corresponds with the profit
maximizing level of output, of the various mix of labor and capital used to produce Q1
level of output, the cost-minimizing (optimal) one is given by point B, where the new
isoquant curve, Q1, is tangent to the new isocost line, C1. The new optimal mix is located
to the right of the original mix, implying that the firm’s demand for labor will always
increase as the wage falls. However, the fall in wage does not necessarily increase the
use of capital. We can thus conclude that the long-run demand curve for labor is also a
downward sloping curve (see figure 3-8 below).

Wage (Birr) Capital

C1/r D

A Q1

Empt labor
L0 L1 L0 L2 L1 c0/w0 c1/w1
Fig. 3.8: the LR demand for labor Fig. 3.9: Substitution and scale

Substitution and Scale Effects

The movement from point A to point B happens as a result of wage cut. It is possible to
decompose such a move into substitution and scale effects. In particular, the wage cut
reduces the price of labor relative to that capital. The decline in the wage encourages
the firm to readjust its input mix so that it is more labor intensive. In addition the wage
cut reduces the marginal cost of production and encourages the firm to expand. On the
whole, the demand for labor becomes high as the firm expands and takes advantage of
the fall in the wage rate.

Initially the firm is producing Qo level of output and faces Wo wage rate, where it
demands to units of labor. As the wage falls to W1, the marginal cost declines and the
firm expands its production to a level of Q2 units, there by employing L1 units of labor. If
we decompose the move in to two stages, firmly the firm takes advantage of the wage
cut by expending production. Since labor and capital are normal inputs, using the same
analogy of normal goods the demand for both labor and capital increases following the
expansion of production. It is worth noting that the newly introduced isocost line is
parallel to and has the same slope as the original isocost line so that the new tangency
point C shows the expansion in output as both capital and labor increases
proportionately. The move from point A to point C is defined as the scale effect. The
scale effect thus increases both labor and capital.

Secondly, the wage cut makes labor cheaper than before. This leads to the
rearrangement of input combination towards the labor- intensive techniques of
production. The analysis of such an effect, substitution effect, is undertaken by holding
output fixed. So the movement along the new isoquant curve, the move from point C to

point B, reflects the substitution of labor for capital. Unlike the scale effect, the
substitution effect increases the firm’s demand for labor but reduces the firm’s demand
for capital.

Whether the firm demands more capital as wage falls depends on which effect
outweighs. If the scale effect, which increases the demand for both inputs, exceeds the
substitution effect, the wage cut will make firms hire more capital. Otherwise, the firm
would use less capital as the wage falls.

3.4 Elasticity of Labor Demand

The responsiveness of labor demand for a change in the wage rates measures the
elasticity of labor demand. It is possible to measure both the short-run and long run
(i) the short-run elasticity of labor demand ((SR):- it is defined as the
percentage change in the short-run demand for labor (LSR) resulting from
A 1 percentage change in wage (w)

(ii) the long-run elasticity of labor demand (SLR) :- it is defined as the

percentage change in the long-run demand for labor (LLR) resulting from a
1 percentage change in the wage (w)

Note that the labor demand curves being downward sloping, the elasticity
measures of both the short-run and long run labor demands bear negative sings.
The imprison of elasticity between short-run and long run demand for labor
indicates that the long-run elasticity of labor demand is greater than the
short-run labor demand elasticity. This is because of the fact that in the long run
the time period is long enough to adjust capital and labor input combinations in
response to changes in the wage rate. But in the short run the time period is too
short to adjust its size optimally.

3.5 The Elasticity of Factor substitution

The elasticity of substitution is a summary measure of the shape of the isoquant and

thereby, of the ease of substitution between labor and capita. The elasticity of
substitution between labor and capital (holding output constant) is given by
Elasticity of substitution = Percentage change in the ratio of capital to labor
Percentage change in the slope of the isoquant
Or Elasticity of substitution = Percentage change in the ratio of capital to labor
Percentage change in the slope of the input

The elasticity of substitution is used to measure the curvature of the isoquant. Let’s
consider two extreme cases of the isoquant curve. First, if the isoquant curve is a
straight line, the marginal rate of technical substitution (the slope of the isoquant curve)
remains constant as we move along the isoquant curve. (See Fig 3.10) (a) below)

Qo isoquant

Q0 isoquant


Labor Labor
(a) Perfect substitutes (b ) perfect complements
Fig 3.10: Two extreme curvatures of Isoquants
When labor and capital are substituted at a constant rate irrespective of the initial
amount, they are called perfect substitutes. The amount by which one input replaced by
another is determined by the slope. If, for example, the slope of the isoquant is unity, the
two inputs will be exchanged on a one-to-one basis.

The other extreme case appears to happen when the two inputs are perfectly
complementary, i.e. the isoquant curve is a right-angled one (see Fig 3.10) (b) above).
We can either add more workers by holding capital at some constant value, Ko or add
more capital by holding labor constant at a value of Lo; hours, in each case output

remains the same. Thus a cost- minimizing firm has only one optimal combination of
labor and capital-Ko units of capital and Lo units of labor.

Following this definition of extreme isoquant curvatures, we can measure the elasticity
of substitution between the two inputs. When the isoquant curve is a straight line, the
firm minimizes by producing at either of the extreme points depending on the cheaper
alternative. If input price changes, the firm will shift to the other extreme position. As a
result of this the elasticity of substitution is infinite

Suppose that the substitution between labor and capital is perfectly substitutable. The
techniques of production allow one capital to do the work of three workers (the slope of
the isoquant curve, MRTS, is 1/3). The firm wants to produce 100 units of output.
Suppose also that the price of capital is Birr 750 per machine per week and that the
weekly salary of each worker is Birr 300 What would be the optimal combination> Find
the input combination the firm uses if the weekly salary of each worker falls to Birr 225?

The production function the isocost line before and after the wage cut




Lo=0 Lo

When the two inputs are perfect complements, there is no substitution to speak of
because there is only one optimal mix of inputs regardless of the prices of inputs.
Therefore, the elasticity of substitution becomes zero when the isuquant curve is
right-angled. However a great number of isoquants lie between these two extreme
cases, implying that the more curved the isoquant, the smaller will be the degrees of
substitution, the flatter the cover, the larger the size substitution effect. Therefore the
elasticity of substitution lies between zero and infinity but it is always non- negative.

Marshall’s Rules of Derived Demand

1. Labor demand is more elastic the greater the elasticity of substitution, the
greater the elasticity of substitution, the flatter the isoquant curve is and the
more readily substitutes for one input can be obtained as the two inputs are
more similar
2. Labor demand is more elastic the greater the elasticity of demand for the output.
This proposition arose directly from the fact that labor demand is a derived
demand, and, therefore the amount of labor demanded depends directly on the
volume of output demanded in the product market.
3. Labor demand is more elastic the greater labor’s share in total costs. If labor is
an important input in the production process, the share of labor from total cost
will be large. A small rise in the wage rate leads to a large rise in the marginal
cost of production and, hence, a large rise in the output price. Consumers will
respond by cutting back their demand for the high price product that results in a
substantial fall in employment.
4. The demand for labor is more elastic the greater the supply elasticity of other
factors of production, such as capital. If the two inputs are substitutes then a
rise in the wage rate will produce a substitution towards capital. If the supply
curve of capital is inelastic, the movement away from labor to capital will be
reduced. But if the supply of capital is elastic, firms are induced to substitute
more capital for labor.

4.1. Wage Determination and Resource Allocation
A varying numbers of employers are engaged in a wide range of occupations of
which wage rates are different. The questions that seek answer are that what
determines the variation in the number of workers in each occupation and what
determines the differences in the wage rates. The answers for such questions rely on
the characteristics of the labor and product markets. In this part we are going to see the
determination of employment level and wage rate under a perfectly competitive labor
market, monopoly in the product market and monopoly in the labor market

4.1.1 A Perfectly Competitive Labor Market

The characteristics of perfectly competitive labor market includes
1. A large number of firms competing with one another to hire a specific type of
labor to fill identical jobs
2. Numerous qualified people who have identical skills and who independently
supply their labor services
3. Wage-taking behavior-neither workers nor employers exert control over the
market wage
4. Perfect, costless information and labor mobility
The analysis centers on three issues, i.e. labor market, the hiring decision by a firm, and
allocative efficiency

(A) Labor Market

The labor market has two interacting components, namely the demand the labor, which
reflects the behavior of employers, and the supply of labor, which represents the
workers’ behavior.
Labor demand and supply
The market demand for labor has been shown to be obtained by horizontal summation
of the quantity of labor demanded by employers over a varying amount of wage rates,
similarly the market supply of labor of a particular type of labor is found by summary the
back ward bending individual labor supply curve at each various wage rates. But
observe that the market labor supply curve, unlike the individual one, is not back-ward
bending because in collective terms workers are willing to offer more labor hours at
higher relative wage rates. Put differently, ever though specific people may normally
have back-ward bending labor supply curve, labor supply curves of specific labor
markets generally are positively sloped over realistic wage ranges. Higher relative
wages attract workers away from household production, leisure, or other labor markets
and toward the labor market in which the wage increased.

The market labor supply curve measures the opportunity cost of employing the last
labor hour in this occupation. The upward sloping curve implies that more and more
wage rates are necessary to entice additional hour of labor away from leisure or from
work in different occupation. To attract additional labor to a certain labor market, the
opportunity costs must be compensated by a higher wage rage. Thus, in a perfectly
competitive product and labor markets, labor supply curves measure the marginal
opportunity costs.
The shorter the time period and the more specialized the variety of labor, the less elastic
the labor supply curve. In the short run, increases in the wage may not result in
significant increases in the number of workers in a market, but in the long run, human
capital investments can be undertaken which will allow greater responsiveness to the
higher relative wage.
wage rate
w1 S1
w3 B
w0 A

w2 D1

L1 L0 L2 L3 Labor
Through the interaction of the demand for and supply of labor curves, the market
eventually settles down at L0 unit of employment an dW0 wage rate, making L0 and W0 the
equilibrium level of employment and wage rate respectively. Were the wage rate be at
W1, an excess supply of labor (L2-L1) would occur, putting downward pressure on the
wage rate to W0. Instead, if the wage rate were to fall to W2, and excess demand for
labor (L1-L2) would develop, putting upward pressure on the wage rate to W0. So W0 and
L0 are the only combinations of wage rate and employment level at which the labor
market clears out.

If other factors than the wage rate, the determinants of labor supply or labor demand,
changes, the previous equilibrium position will be disturbed. Consequently the labor
demand and/or the labor supply curve will shift. Note that changes in demand (changes
in supply) and changes in quantity demand (supplied) are defined in a similar manner as
they are defined in the product market. The formal occurs only when the entire curve
shifts which is caused by changes in the determinants, while the latter occurs when the
movement, caused by changes in the wage rate, occurs along the same curve.
Here are the determinants of labor supply and labor demand
(i) Determinants of labor supply
1. Other wage rates:- wages paid in other occupations
2. Non wage income:- income other than from employment
3. Preferences for work versus leisure
4. Non wage aspects of the job:-
5. Number of qualified workers
An increase in either of (1) or (2) leads to a decrease in the labor supply while an
increase in any one of (3), (4) or (5) leads to an increase in the labor supply.

(ii) Determinants of labor demand

1. Product demand
2. Productivity
3. Prices of other resources:- Depending upon whether a substitute results in a gross
complements (output effect > substitution effect) or a gross substitutes (out put
effect < substitution effect)
4. Number of employers
An increase in (1), (2), (4) and gross complement resources yield on increase in the
demand for labor whereas an increase in the gross substitute resources leads to a
decline in the demand for labor.

Changes in demand and/or supply can be graphically demonstrated using the above
diagram, figure 4.1. Suppose that the number of qualified suppliers of a specific grade
of labor increases. For the given wage rate the number of suppliers of this labor will
increase, resulting in a rightward shift in the labor supply curve, from S0 to S1. On the
other hand, suppose also that the price of a substitute resource in production increases
so that the resource is a gross substitute (output effect falls short of substitution
effect). This directly increases the demand for labor and hence the curve shifts right
ward from D0 to D1.
The net effect of these two changes in the determinants leads to having an equilibrium
wage rate of W3 and employment level of L3. Whether the new equilibrium combination
results a higher or lower level of employment and wage rate depends on the net
outcome of the simultaneous changes in supply and demand.
(3) The Hiring Decision by a firm
Because an individual firm is just small to affect the labor market, its decision on how

many workers to hire will not affect the market wage. Rather, this firm is a wage-taker in
the same sense that a perfectly competitive seller is a price taker in the product market

Wage rate Wage Rate


W0 W0

L0 L1 L0
(a) The labor market (b) An individual firm
Figure 4.2. The Hiring decision of Individual firms

To decide on the number of workers a firm will hire we need to compare the above two
curves. The single employers has no incentive to pay more than W0 because at this
equilibrium wage rate the firm is able to attract as many labor hours as it wants. If it
lowered the wage rate, no worker would be attracted so the marginal opportunity cost of
workers with this skill must not be less than W0. This indicates that the labor supply
curve that faces an individual firm is perfectly elastic, horizontal at W0.

Similarly, the labor supply curve for an individual firm (4.2(b)) indicates also the average
and marginal wage costs.

In the short run, a firm’s demand for labor curve is its marginal revenue product curve.
Thus, this firm can compare the additional revenue (MRP) obtained by hiring one more
unit of labor with the added cost (MWC) or in this case, the wage rate (W = MWC). If
MRP > W, it will employ the particular hour of labor; on the other hand, if MPR < W, it will
not. To generalize, the profit-maximizing employer will obtain its optimal level of
employment where MRP = MWC.

If Figure 4.2.(b) Q1 level of employment indicates that MRP exceeds MWC, indicating
that the firm can earn a higher profit if it employs the next hours of labor. At Q1 what the
firm can earn by selling the additional product resulting from employing this worker
(price) exceeds what is pays on the employment of it (wages). This is true for all level of
employment below Q0. Then the firm continues to employ up to Q0. Beyond Q0
diminishing returns finally reduce marginal product to the extent that MRP lies below the
market wage W0 (=MWC). Thus this firm’s total profit will fall if it hires more than Q0

Allocative Efficiency
Labor is being allocated efficiently when society obtains the largest amount of domestic
output from the given amount of labor available. Available labor is efficiently allocated
when its value of marginal product (VMP) the dollar value to society of its marginal
product is the same in all-alternative employments.

Suppose that the same labor A is capable of producing product X and product Y.
Suppose also according to the current allocation of labor the VMP of labor to produce X
and Y are $12 and $8, having the result that VMPX > VMPY. Because labor resource in the
firm that produces product Y is inefficiently used, by transferring a worker from the
production of Y to that of X it is possible to raise the efficiency of this labor. This
reallocation will cause a movement down the VMP curve for X and up the VMP curve for
Y. This means that VMPx will fall and VMPY will rise, and the reallocation continues until
the VMPs across the products are the same, i.e. VMPx = VMPy. Once this equality is
achieved, there is no further reallocation of labor, which will cause a net increase in the
domestic output.

If we expand the example to include n products, the condition for efficient allocation of
any given type of labor is given by
VMPx =VMPY =.........................=VMPn =PL ....................................................(4.3)
Where PL is the price of labor. This equation fells us that human resources are efficiently
allocated when the value of the last units of labor in various labor market uses
(producing goods X, Y,.... n) are all equal and these values in turn are equal to the
opportunity cost of labor PL (the marginal value of alternative work, non-labor market
production and leisure). Alternatively, an under allocation of a particular type of
labor-to-labor market production occurs when its VMP in any employment exceeds PL;
an over allocation occurs when its VMP in any labor market employment is less than PL.

Under the perfectly competitive product and labor markets, the equilibriums for the
production of n products occur at a level of employment where profit is maximized by
equating MRPs with MWC. In a perfectly competitive market labor is hired at which
PL=MWC and the products are sold at a point where MRP = VMP for all the products.

Thus each firm maximizes profits where MWC = MRP. But because PL= MWC and MRP =
VMP for all competitive firms using the same labor, allocative efficiency condition is
fulfilled under such a market. In short, competitive labor markets do result in an efficient
allocation of labor.

4.1.2. Monopoly in the Product Market

Unlike a competitive firm, a monopolist firm faces a downward sloping demand
curve in the product market, meaning that increases in its output will require
reductions in price and that its marginal revenue (MR) will be less than its price.
Consequently the MRPL (= MR X MP) will fall because, firstly, because of
diminishing returns MP will decline when more labor is hired. Secondly, MR will
decline faster than price. As shown in Figure 4.3 below a monopolist faces a
downward sloping demand curve and MR curve but a horizontal labor supply
curve, indicating that this firm is a wage-taker.

Wage Rate


Dc = VMP (MP X P)
Quantity of Labor

Qm Qc DM = MR P (MP X MR)

Figure 4.3: Wage rate and employment determination under monopoly.

Labor demand curve DC is the MRP curve that would have occurred had there been
competition rather than monopoly and therefore no decline in marginal revenue as the
firm increased its employment and output. This MRP curve would be equal to VMP; the
firm’s revenue gain from hiring one more worker would equal society’s gain in output. On

the other hand, demand curve Dm is the monopolist’s MRP curve. In this case, MRP, the
value of the extra output of each worker to the monopolist, is less than VMP, the value
to society. The monopolist’s sale of an additional unit of output does not add the full
amount of the product’s price to its marginal revenue.

Comparisons of perfectly competitive in both product and labor markets and

monopolistic firm in the product and competitive in the labor market have the following
1. The monopolist’s labor demand curve Dm is less elastic than the competitive
labor demand curve DC
2. The monopolist behaves in the same way as the competitive firm in determining
the profit-maximizing level of employment where MRP = MWC. Nevertheless, this
equality produces a lower level of employment, Qm, than would occur under
competitive product market conditions, Qc.
3. The wage paid by the monopolist is the same as that paid by the competitive
firm, because both are wage-takers
4. Labor resources are misallocated
The last outcome needs further description obviously, efficient labor allocation requires
that VMP = PL. In a perfectly competitive market PL (=W) reflects the marginal
opportunity cost to society of using a resource in a particular employment and VMP
reflects the measure of the added contribution to output of a worker in a specific
employment. Under a monopolist, the profit maximizing level of employment is given at
Qm where VMP > PL (W0), implying that too few labor resources are being allocated to this
employment and therefore two many labor researches are allocated somewhere else.
The same is true for the level of employment until QC.
4.1.3 Monopsony
In this part the focus is on the conditions in the labor market only. A single firm
dominates the labor market or two or more employers are collided to fix below
competitive wage. They are respectively referred to as pure monopsony and joint
monopsony. The discussion in this part is confined to pure monopsony in the labor
market and perfectly competitive in the product market.
1. There are numerous qualified homogeneous workers who act independently to
secure employment in the monopolized labor market
2. Information is perfect and mobility is costless
3. The monopolist is a wage-setter, it can control the wage rate it

Pays by adjusting the amount of labor it hires

Consider the following table as a hypothetical example
Units of Wage TWC MWC MRP
labor (AWC) (VMP)
1 1 1 1 7
2 2 4 3 6
3 3 9 5 5
4 4 16 7 4

5 5 25 9 3
6 6 36 11 2

Observe that the first two columns indicate that the firm must increase the wage rate in
order to induce workers supply more units of labor. Notice also that the firm cannot
wage discriminate when hiring additional workers, in the sense that it must pay the
higher wage to all workers including those who could have been attracted at a lower
wage. Depicts that the value for total wage cost (TWC) is obtained by multiplying the
units of labor by AWC. Also the MWC, the extra cost of hiring one additional unit of
labor, is greater than the wage paid for that unit, indicating that MWC> AWC for each
unit of labor. The monopolist’s MWC exceeds the wage rate (AWC) because it must pay
a higher wage to attract more workers, and it must pay this higher wage to all workers.
The last column indicates the firm’s MRP, which is the firm’s short run labor demand
cure and equal to VMP.
Since the monopolist firm is a single firm is a single firm that faces the labor supply
cure for a given occupation, this curve must be up-word sloping. Because of the
existence of a sole hirer in the labor marker MWC>AWC and hence MWC lies above
AWC. The labor supply curve and AWC are the same. This being the case our interest is
to determine the equilibrium level of employment and wage rate. The above table can be
used to depict the determination graphically. Every profit-maximizing firm needs to set
MWC at MRP. This equality point is located at point A in Figure 4.4 below, where the firm
employs Q1 units of labor.

Wage rate B SL=AWC

W0 C

W1 E F

Quantity of labor

Q1 Q0 Q2
Fig 4.4 wage rate and employment level determination under Monopsony

If the firm were to employ Q0 units of labor, its MRP would be at point c and its MWC is
at point B. yielding a loss equal to area ABC. So the profit maximizing condition dictates
the firm to employ only Q1 units of labor, where MRP equals MWC. The corresponding
wage rate for Q1 level of employment is traced by moving along the labor supply curve
not along the labor demand curve. The labor demand curve (MRP schedule) is only used
to select the profit maximizing level of employment. Note that at W1 wage rate the firm
is willing to hire Q2 units of labor while workers are willing to offer only Q1 units of labor,
leaving the monopolist with a job vacancy of EF. But, as we mentioned above, the firm
can not raise the wage so as to equate demand and supply, rather it restricts the
quantity of labor hired and pays (1) lower than competitive wage and (2) a wage below
the MRP of the last unit of labor employed

4.2. Alternative pay packages

Apart from the hourly wage rates, several kinds of compensations are prevalent in the
labor market the most important pay packages include fringe benefits and pay-ter
performance plans like piece rates, commissions, royalties, raises and promotions,
personal and team bonuses and profit sharing. This section is intended only to
introduce these concepts rather than to go to the details of them.
Fringe benefits: it includes leg ally mandated public programs such as social security,
unemployment compensation, and workers compensation They also include many
private non-mandatory programs such as private pensions, medical and dental
insurance, paid vacations, and sick leave. Fringe benefits can increase the utility that
workers receive from a given amount of total compensation. It can also benefit the firm
by permitting it to retain and attract high-quality workers.
Principal agent problems
The explanation of the relationship between pay and performance stems from the
principal-agent problem. By agents we mean workers who are hired to advance the
interests of others and principals are firms who hire others to help them achieve their
objectives. Employees are willing to help firms earn profits in return for payments of
wage income. This income enables workers to buy goods and services, which yield
utility. Thus, the relationship between principals (firms) and agents (workers) is based
on mutual self-interest. But it does not mean that all their interests are identical. In
situations where conflicts of interests arise the principal agent problem happens.
Firms would like that employees would work all agreed upon hours at agreed-up on
efforts. Employers, in contrast, would like to engage in opportunistic behavior to
enhance their utility objective. For example, workers increase their leisure by shirking, by
either taking unauthorized work breaks or giving less than agreed-upon effort during
work hours. In order to ovoid such problems firms follow different mechanisms, two of
which one discussed below
(i) Pay performance
To reduce the principal-agent problem, employers arrange some incentive pay plans
which are directly associated with performance or output. Such plans include

1. Piece Rate- are compensations paid in proportion to the number of units of
personal output It is often found in situations where workers confront the pace
of work and forms final it expensive to monitor work effort.
2. Commissions and Royalties:- they tie pay to the value of sales commissions are
commonly received by realtors, insurance agents, stockbrokers and sales
personnel. Royalties also are set as a percentage of sales revenue, paid typically
to authors, film producers and artists
3. Raises and promotions:- workers receive time payments as fixed annual salaries
because they are regarded as quasi-fixed resources Lawyers, accountants,
managers and personnel are some cases in point that do not change in relation
to the level of production.
4. Bonuses:- payments beyond the annual salary based on some factor such as
personal or firm performance their advantage to the firm is that they may elicit
extra work effort. Another advantage is that they do not permanently raise base
salaries or hourly wages, as do raises, promotions or other forms of merit- pay
5. Profit sharing:- is a pay system that allocates a specified portion of a firm’s
profits to employees, It has become increasingly common for senior executives
in large corporations.
(ii) Efficiency wage payments
Direct observation of workers at the job, monitoring the efforts of the workers, is
expected to reduce the principal-agent problem. Fearing the loss of their jobs, most
workers will not shirk when they are being observed. Supervision therefore may be
an effective way of reducing the problem in some circumstances

Monitoring workers, however, is very costly in some employment circumstances, like

scanty guard, house painter and manager. Under such type of jobs employers are
recommended to use a mechanism that pays workers a wage above the
market-clearing level. Such mechanisms apart from avoiding the costly supervision
is expected to reduce the likelihood of quitting jobs and the resulting costly labor

4.3 Critiques of Conventional Wage Theory

Thus far the explanation of wage and employment level determination centers or the
marginal productivity theory. Through the interaction of the demand for and supply
of labor, the equilibrium wage rate and level of employment are determined. With the
objective of meeting their own interests, supplies and demands of labor come
together into the labor market and agree to exchange at the market clearing wage
rate. This market clearing mechanism becomes a dynamic process if any of the
determinants of labor supply and/or labor demand changes.

The determination of wage in such a way however has been subject to various
critiques and the subsequent alternatives since the 1940s. Three major conceptions
of labor markets developed since than to explain the way the labor markets are
determining wage rates, employment and allocation of human capital investments.
These views include the institutional economics conception of the labor marker, the
nation of internal labor markets and the segmentation theory of labor market. What
makes these views different from the conventional theory, which the economic
forces underlie, the determination of labor markers, is that in the recent views unions
and collective bargaining, customs and habits, administrative rules and procedures,
and the institution of discrimination are common and important determinants.
In what follows we will see the institutionalist view of the labor market the explanation
of the remaining two views is postponed to the next chapter.
Institutional Economics and Wage Determination
The earliest critique of competitive wage setting has come from the institutionalists
during the 1940s.According to this group of economists strong unions and collective
bargaining play a more significant role in the wage setting than economic forces do
the institutionalists criticize the orthodox wage theory on the grounds of
1. Conscious Human Decisions:- According to the institutional its, the evaluation of
collective bargaining has had the effect of making the wage rate on administered
rate, rather than a market rate. Wages are determined by the conscious human
decisions made by union of organized labor and the management
representatives of large corporations around the bargaining table, rather than by
the impersonal market forces of demand and supply. They argue that it is more
accurate to say that supply and demand adjust to wag rates than to contend that
supply and demand determine wages
2. Unions as political: -
Union leads are subject to pressures from union members, rival leaders in the union,
rival unions, employers, and government. Labor unions can be conceived as political,
rather than economic, institutions that face pressures form the stakeholders so that
the union leaders should struggle for the survival of their leadership and the union
they represent Notice that the labor market outcome depends on the relative
strength of the parties involved in coactive bargaining rather than the marginal
productivity of labor Economic forces, thus are significant only to the extent that
they generate political pressures which union leaders must cope.
According to the economic analysis of labor market, if the consumer demand for a
product were to fall, the economic forces would lead to shifting the demand curve
inward and cutting back the wage rate and employment level. Rather, wage and
employment determination rely on the relative bargaining power of employers and
the pressure exerted by the union members on their leaders.

In the political context that dominates the bargaining process, the wage rate
becomes an instrument, which is manipulated in the interest of furthering the
reputations of union leaders and the security, growth, and prestige of the union as an
3. Inappropriateness of Maximization Principles
Unlike the employers and employees, labor unions do not have clearly defined
objectives. Being agents not severs of labor, the unions have a brood objectives
which are measured from several dimension the purpose for which the unions are
established includes wages (with a pecuniary dimension), hours of work (with a time

dimension), physical working condition, economic security, protection against
managerial abuse, and various rights of self-determination, (without any dimension)
while bargaining with employers in fixing wage rates union leaders should take into
account all these conditions along with employment determination, making the
volume of employment unpredictable. So the conventional wage- employment
relationship is concealed by an array of external factors about which unions are so
concerned that they disregard the maximization principle.
4. Equitable Comparisons
On rejecting the maximization principle, the labor unions’ wage policy is formulated
on the bases of equitable comparisons- ideas of fairness and justice whether or not
a given wage settlement is satisfactory to workers, to the union as an institution or
to the employer is strongly determined by how that wage compares with what other
comparable workers are getting and other employers are paying.
Such comparisons also reveal how well one union has done compared to others,
thus demonstrating to the union members whether they are getting a fair return for
their union dues. Similarly, employers desire to avoid wage bargains, which are out
of line compared to other employers.

4.4. Minimum Wage Theory

Controversial as it has been, many governments have been exercising minimum
wage law to ensure that workers receive a living-wage the minimum wage level is
dot at a level that enables a full time worker to buy the basic necessities of life. In
what follows first we consider the impact of minimum wage law on both the
completive and monopolistic labor markets, and next the arguments for and against
practicing the minimum wage law.

4.4.1. The competitive Model

Here both the product and labor markets are competitive the analysis of this model
is decomposed into two: covered and uncovered labor markets. By covered, or
sometimes complete coverage, we mean that all the employs in the economy are
covered by the minimum-wage law.


Wm A B C

W0 E

Qa Q0 Qs
Figure 4.5. Minimum wage effects under competitive model
Given the profit-maximization condition, the equilibrium wage and employment are
indicated at w0 and Q0 respectively. Setting the minimum wage rate at or below the
market clearing level is of no avail to wages and employment.
If the government impose a minimum wage level wm, then
∙ Employers will hire only Qd workers because the MRP of labor above Qd will
be less than the minimum wage- the employer will reduce employment.
∙ The supply curve suggests that the minimum wage will attract Qs units of
labor, Yielding the unemployment amount of AC
∙ The minimum wage creates a locative inefficiency, this is because the VMP
at Qd units of labor, point F. In other words the level of output given up by the
society resulting from minimum wage law, Qd QoQd EA, is greater than the
displaced workers can contribute in their most productive employment
marginal opportunity cost, Q0 Qd FE. The difference, area FAE, gives the net
less of domestic output
To conclude, first, other things being equal the higher the minimum wage relative to the
equilibrium wage, the greater the ergative employment and a locative efficiency second,
the more elastic the labor supply and demand curves, the greater the unemployment
consequences of the law
On no account can all the labor markets be covered by the minimum wage law. Even
when many of the industrial sectors are covered, a lot of agricultural and service sectors
may be uncovered. So the coverage in this case is so incomplete that covered and
uncovered labor markets exist together. For the sake of simplicity assume that
migration between the covered and uncovered sectors is costless and there is perfect

S S1

Wm A

W0 C' B W0 C


Du = VMPu
C1 C0 U0 U1

(a) Covered sector (b) uncovered sector

Figure 4.6 the covered and uncured sector minimum wage model
Before the imposition of the minimum wage law, the level of employment that
corresponds with the equilibrium wage wo is given by co for the covered sector and uo for
the uncovered one in Figure 4.6 The establishment of minimum wage level of wm in the
covered sector only drives wedge between the two sector level of employment in the
covered sector only c1 and in the uncovered u1 amount of labor will be employed.

Since migration is costless and information is perfect, wage-fixing practice gives rise to
the migration of displaced workers from the covered sector to the uncovered sector.
This is because the firms in the covered sector respond to the government's action by
displacing workers equivalent to c1 co. This displaced workers will cause a shift in the
labor supply curve in the uncovered sector, rightward from s to s1 following this effect
the model is also referred to as the spill-over model Note that in both sectors
employment takes place at a point where demand and supply are equal. Following this
condition the equilibrium employment in the covered sector is c1 send in the uncovered
sector is u1, where u1=u0 +(c0-c1).This additional supply of unskilled labor, displaced from
the covered sector, shifts the labor supply curve there by reducing the equilibrium wage
to wu.
The outcomes of the labor market resulting from the minimum wage law can be
summarized as
1. the minimum wage will benefit those workers in the covered sector who are
fortunate enough to retain their job because their wage rate increases from wo to
2. The implementation of the law reduces employment in the covered sector from
co to c1, displaces some workers (c0-c1) and increases employment in the
uncovered sector from u0 to u1 by the displaced amount, having a net effect of
3. The law reduces the wage of unskilled workers in the uncovered sector from w0
to wu.
4. The law causes a misallocation of resources
The last point is worthy of further discussion the displaced workers from the covered
sector reduce society’s output and income by the area given ABC0 C1 where as these
same workers being shafted to the uncovered sector increases the society’s output and
income by CEU1 U0.Since the area that represents loss from the covered sector exceeds
the area that represents gain from the uncovered sector. Consequently, the difference
the area AEC’ E’ in the covered sector represents the net loss to the society

4.4.2. The Monopsony Model

The analysis under this part consider that the labor market is nondiscriminating
monopsony comprising either only a single employer or many buyers being collided with
the effect of setting wages below market clearing level. In Figure 4.7 below and the
explanation we had about the determination of wage and employment under
monophony the MWC curve lies above the AWC and the equilibrium wage & employment
are a point where MWC=VMP. Following this rule Q0 and W0 are equilibrium employment
and wages rate respectively.


W2 A B


W0 C
Q0 Q1
Suppose that the government sets a minimum mage rate between W0 and W2. The
labor supply curve will be horizontal until 0Q1 units of labor if the government sets
the minimum wage at W1, and hence AWC=MWC over this range with the legal
minimum wage of W1, the monopolist becomes a wage taker rather than a wage
setter and employs 0Q1 units, at which AWC=VMP. This gives rise to an additional
employment of Q0Q1 resulting from the imposition of the legislation contrary to the
monopoly power of the employer if the government set the minimum wage
somewhere between W0 and W2, the level of employment expecting the wage rate in
such a way that the selected wage rate ensure the maximum possible employment
and a locative efficiency
Care must be given while selecting the minimum wage
1. if government sets minimum wage above W2, employment level will be less than
2. even though employment may be equal to or greater than Q0 at minimum wage
levels above monophony wage W0, unemployment could easily be higher. Under
monophony wage of W0, there was no unemployment because of the equality of
the demand for and supply of labor, which are given at point C. But if the wage
rate is raised to a level of W2 the demand for labor, point A, falls short of the
supply of labor, point B, resulting the unemployment level of AB.
3. being the only employer of a specific type of low wage labor, a monopolist might
be able to discriminate, that is, to pay each worker a wage just sufficient to
attract her or his employment. If so, the MWC curve will coincide with the labor
supply curve, and the firm’s profit maximizing level of employment (MWC=MRP)
will be the competitive one, Q1, rather than Q0.
4. Empirical evidences indicate that the minimum wage
∙ reduces employment, particularly for teenagers
∙ increases unemployment. Of teenagers by less than the reduction in
∙ reduces the amount of on-the job training offered to low wage workers
but encourages school attendance for those unable to find work
∙ does not greatly after the degree of family income inequality and extent
of poverty.



5-1 Basic Concept of the Labor Market

Simply the labor market can be defined as the market that allocates workers to jobs and
coordinates employment decisions. Workers make several decisions regarding to
whether to work, or not, how many hours to work, what type of job to take in, when to
change and when to quit jobs On the other hand, employers make such decisions as
how many workers to hire, to produce, whom to hire, what type of technologies to use,
and how much to compensate. All these decisions are coordinated in the labor market.
Put differently, the decision-making process in one party is influenced by the behavior
and decisions of another because of the existence of good deal of buyers and sellers.

In the labor market employers are buyers of labor service and workers are sellers of
their services, there by making the labor market as the composition these two main
agents. The labor market can be national, where buyers and sellers are searching
throughout the entire nation, or local, where buyers and sellers are confined to some
local area. Some labor markets may operate under the rules and regulations set by the
labor unions. In such a case, the sellers are organized in some sort of labor unions so
that the terms of contract between workers and employers are dealt through the rules
and procedures set by the union. Buying-selling transactions in some other markets may
not take place through the formalize rules and procedures. But it does not mean that
such markets are completely unstable and paying low-wages.
Features of Labor Markets
Labor markets are different from markets for consumer goods and services.
Peculiarities of labor markets involve
1. Multiplicity of Markets: there is a great deal of interrelated markets for labor. The
multiplicity feature can be explained from the skill level and geographical spread
point of view. Labor markets are so interrelated that workers can make choices
among occupations and geographical areas. Nevertheless, movements across
occupations and local and national labor markets involve costs that result from
the barriers set by different labor markets. Thus the labor market analysis need
to identify the main barriers that exist in reality and suggest solutions to reduce
such barriers
2. No standardized workers:
The labor services of workers are not so standardized as goods Disparities
among workers can be explained by age, sex or race or by productive capacity of
workers including intelligence, manual dexterity, physical strength and energy,
and work motivation. Although firms face these differences while recruiting
workers, they can set several criteria to select the best worker and put them
under a probationary period of work. Moreover, type of formal education, years
of work experience and amount of specific job training are the elements that
contribute to variations among workers. However, investments made to upgrade
the impotence of the worker, by the worker or employers, play important role to

close the gap in skill levels, there by, to raise the expected rewards.
3. Continuity of Employment Relation:
Unlike a consumer whose daily activities of buying and selling of commodities
are not in treated, an employer cannot hire and five workers very frequently. Once
a worker is hired with some skills, he is expected to keep the norms of work and
to stay long on the job. Following this expectation, the employer will invest to
train the worker and, through time, the workers will be experienced so that the
worker’s productivity will increase. So if the employer fire such a trained and
experienced worker, he can hardly find a new worker with the required level of
skill and the investments made in the worker will not bear fruits in the firm. Thus
the employer prefers to let the worker work continuously in the organization as
far as the worker is line with the norms set therein.
Prefacing continuity in the same work place is also observed from workers
themselves. Familiarity with work routines, working conditions and work
associates makes life secure and pleasant. As the workers service year's
increase, the more beneficial will be for the worker to stay in business in the
same organization.
4. Workers deliver themselves along with their labor
It is impossible to detach the workers from the services of labor they sell. Hence
the physical and social working conditions matter when the bargain takes place.
In other words both pecuniary-the wage available in the market-and
non-pecuniary factor-risk of injury, working environment, supervision and pace of
work-are worth considering while employment transactions are carried out.
5. Worker’s Inferiority in Bargaining Power
Because vacancies fall short of the number of workers searching for jobs,
workers have hardly any bargaining power in the labor market. Employment
conditions are dominantly set according to the interests of the employers. The
workers bargaining power is weakened by the meager availability of alternatives
and the state of demand for labor. As the demand for labor is a derived demand
for products of the firm, when the firm's sale is cut back or when the economy is
in recession, the demand for labor may fall. The individual’s skill and ability are
also the factors that determine the worker’s bargaining power. The higher the
skill and ability acquired by the worker, the more considerable the bargaining
power will be. The lower the skills possessed by the worker, as the case in most
workers, the weaker their bargaining power will be.

The Role of Organizations in the labor Markets

Labor markets have been serving as an effective instrument to bring improvements in
the living standards. Changes in the technology give rise to a steadily increasing
productivity that, in turn, increases the relative wage rates and general wage level of the
economy. This market also plays a substantial role in the assignment of workers on the
jobs in accordance with their skills and interests. Wage inducements rather than
administrative methods are evidenced to be effective mechanisms to allocated and
attract the desirable workers to the requisite jobs.
It does not, however, mean that labor market is a panacea for all sorts of troubles that
may arise in the terms of employment. Labor markets, for example., fail to regulate the
working conditions-both physical and social-because of their qualitative and intangible
nature. The workers cannot detect such bad working conditions beforehand; even so, it
is hard for them to bargain individually in the labor market. Then, collective bargaining
through the unions will be regarded as a means to defend their interest.

Apart from the union organization, government interventions are also required to rectify
the malfunctioning of labor markets when disabled and low-skilled workers are deprived
of the proper protection. Besides, the government can establish different standards for
minimum wage rates, and din areas where labor market is ineffective.

It is worth noting that institutions, trade unions and governments, serve to supplement
the labor market rather than to compete with it.
1. they provide a precise answer to questions on which the market gives only
general guidelines. For example when the market determines the exact wage
rate of the worker, the institutions bargain over the non wage terms of
2. Market and institutional pressures work in the same direction

5.2 Theory of labor markets

Characteristics of a fully competitive labor markets
1. The are many workers and employers in the labor market so that no one has an
appreciable influence on the market wage
2. There is free entry and exit for workers and employers so that workers can freely
more from one employer to another
3. There is no organization on either side of the market and there is no wage fixing
by the government
4. Workers and employers are well informed. Workers know about vacant jobs, the
wage rates they are paid, and other terms of employment. Employers are aware
of workers available for work, the wage that attracts workers
5. Economic motivation is dominant. A worker prefers a higher wage to a lower
wage holding other things constant.
6. The attractiveness of a job is measured solely by its hourly wage rate. Other job
conditions are taken as given and constant
7. All job vacancies are filled through the market. No internal promotion exists
8. Workers are interchangeable from the eyes of employers and are of equal

Market Demand
From the previous explanation we grasped the individual demand for labor as well as
the industry’s labor demand curves are downward sloping. Despite the differences in
technology labor demand functions market structures, and price elasticity’s of demand
among firms and industries, aggregating the demand curve for the occupation is made
by taking into account the fact that what is true of the parts must be true of the which.
Wage Rate Wage RateW1


Employment Employment
L0 L2 L1 L0 L1 L2
(a) Market Demand for Labor (b) Market Supply of labor
Figure 5.1: The labor demand and supply schedules
Figure 5.1(a) illustrates the labor demand schedule for the occupation. It indicates that
the market demand curve labor slopes downward to the right. When the wage rate
changes, holding other factors equal, the level of employment moves along the initial
demand curve for labor, Do. Any change in the factors held constant brings in a shift in
the demand curve. If, such a change leads to increasing demand, then the whole
demand schedule will respond by shifting inward to the right, such as D1.

Market supply
Decision on occupations choices is reached after considering several characteristics of
a certain occupation that includes such conditions of worke as the working hours, the
effects to be exerted, the regularity of employment and the pleasantness of the work.
Each worker places different weights for these different characteristics and tend to
select the one that, in balance, offer the greatest net advantage.

In spite of the existence of several factors that influence the workers’ occupational
choices, in order to draw the labor supply curve we can reasonably single out the wage
rate on the basis of the following ground:
§ Wages are measurable while other considerations are not
§ Income remains to be an important factor in occupational choice
§ Wage rage is one of the more flexible characteristics of an occupation so wage
is highly likely to vary in the short run.
To simplify matters, the time period is so short that the other considerations of an
occupation remain constant. All the characteristics in all other occupations, including

wage rate are implicitly assumed to be given and constant so that the analysis
concentration a single occupation. When the wage rate in this specific occupation
increases relative to all other occupations, the net advantage that could general from
this occupation will increase, and there by, workers are induced to move to this
occupation. The labor supply curve will be upward sloping.

Figure 5.1 (b) depicts a movement along the same supply schedule when the wage rate
changes every thing else remaining unchanged. It also graphs the increase in supply,
which occurs because of the change in either of the considerations on that specific job,
but its wage rate is given.

We have to be cautious in regarding the labor supply curve as upward sloping curve in
some occupations, like professional, technical and engineering specialties, the rise in
wage rate may not bring about immediate effect on employment level. Supply of labor
does not adjust to a higher wage rate. So the labor supply curve will become vertical

Market Equilibrium
The interaction of the demand curve for labor and the supply curve of labor determines
the number of workers employed in each occupation and the going wage rate in the
labor market
Wage Rate


E Employment

Fig 5.2. Equilibrium in the competitive labor Market

If the wage started at a higher value than at the wage level W, there will be more workers
searching for the job than employers are willing to hire. This makes some workers to
accept a lower wage offer that results in a down ward pressure on the wage rate until it
reaches the equilibrium level. In contrast, there will be an upward pressure on the wage

rate if the wage rate falls below the level of W wage rate because some employers offer
a little more money to attract the workers they need. So the labor market is in
equilibrium when the wage rate is at W and the level of employment is Q + E. At this
market-clearing or competitive wage, the number of workers searching for work is
exactly equal to the employers are willing to hire.

It is worth adding the type of supply curve an individual firm faces. In a competitive
market, the supply curve to a firm is horizontal at the completive market wage level. In a
given occupation, where all the considerations except wage are assumed to be
constant, workers make choices of employers on the basis of the going wage in the
market. If a single firm in the industry offers wage below this market wage, it cannot hire
anyone as applicants move to other employers. A firm would be foolish enough to pay
above the going wage . In order to hire as many workers as it needs, the firm has to pay
the going wage like any other firms. Thus, the labor supply curve of the single firm is a
horizontal line.

Shifts in Demand and Supply

Even if labor demand and labor supply interacts to determine the equilibrium wage, the
labor market will exhibit surpluses or shortages. When the current wage rate lies above
the equilibrium wage, the demand for workers falls short of the number of workers
wanting jobs-surplus labor prevails in the labor market. Trade unionism and
government’s regulation of minimum wage are the major reasons why the wage rate
remains above the market-clearing level. In either case the employers are not able to
lower wages so as to attract additional workers.

On the other hand, when the wage rate falls below the market-clearing level, shortages
will prevail in the labor market. However rare such cases are, wages are intentionally
kept below the equilibrium level so that workers will not concentrate in some localities.
Put differently, because of the low wage in urban areas, for example, some workers will
move to rural areas where scarcity of workers looms larger.

Let’s turn to the situation in which the equilibrium wage exists and consider what
happens to this equilibrium condition when the labor supply and labor demand curves
shift outward (when both demand and supply schedules increase). As jobs become
easier through technological progress, non wage conditions of the job are improved,
regulations are set to encourage the participation of formerly excluded group of workers
and number of trained and skilled workers rise, the supply curve of figure 5.3 (a) could
shift to the right from S0 to S1.
wage rate wage rate
S0 D1
D0 S1 D0 S0


L0 L1 Employment L0 L1 Emplt
(a) (a) Shifts in Supply (b) Shifts in Demand
Figure 5-3 Shifts in Demand and Shifts in Supply

The right ward shift in supply leads to a rise in the level of employment, E,, and a fall in
the wage rate, W1. Thus, increased labor supply to an occupation, other things remaining
unchanged, will raise employment and lower the relative wage in that occupation. The
converse happens to a decrease in the labor supply.

As the demand for the industry’s product increase, the demand for the labor that
producer this product will’ increase. Figure 5-3(b) indicates that following the shift in the
labor demand, both the employment level in the occupation and wage rate increase. We
can, thus, conclude that increased demand for a particular occupation, other things
being equal, will raise both employment and the relative wage in that occupation.

To understand why the pattern of employment is changing over time, changes in labor
demand are more important than changes in labor supply. Changes in labor demand
make employment and wage both rise. We can then ask which economic variable
change more Obviously, the answer depends on the relative position of the labor supply
schedule (the elasticity of labor supply). If the labor supply come is relatively steep, then
the change in relative wage will be greater than the change in employment. But if the
labor supply curve is completely elastic, as supported by research evidences, then an
increase in demand will entirely be reflected in employment, leaving the relative wage

5.3 Internal and External Labor Markets

Employers usually have two options to fill a job vacancy. The first option involves hiring
a new worker by participating the labor market, referred to as the external market. The
second option is by promoting the formerly employed workers to the vacant position. A
good example of external market is secondary markets, where jobs are not attractive,
wages are low, on-the job training is very little and turnover of workers is so high. The
basic reason for the existence of secondary labor markets is that the job does not
require workers with much skill, rather the job can be learnt with in a few hours.

On the other hand, there are firms where a good deal of workers with considerable
teamwork is necessary. In such firms the product demand, and thus the labor demand is
so relatively stable that the firm can invest considerable resource in training and
motivating its workers. In order to gain from investments of this kind, the wage rate in
such labor markets must be high enough to attract and retain’ highly skilled workers.
Consequently, the rate of turnover in these firms is very small and there is hardly any
mobility of workers across employers.

Vacancies in such firms are filled by mobilizing workers across occupations within the
firm through promotions or lateral transfers. There is no need of hiring new entrants,
except for a few entry-level positions, from the external market, rather the positions are
filled from the internal markets. Large firms are characterized by very highly developed
internal labor markets and long leaders of promotions.

Nevertheless, the interaction of demand and supply do not have any rote to determine
the wage rate of internal labor market. The wage rate simply set by administrative rules
or by unilateral or collective bargaining’s. Once the worker is hired at the entry-level jobs,
ports of entry, from the external market, the worker will be assigned to a ladder of
higher-paying positions through the internal labor market. Sometimes the wage rate
increases as the worker masters additional skills while remaining in the same job

As the pay is high, the mobility across employers is little and the working conditions are
better highly developed internal labor markets can be grouped under the primary labor
market. To put in the words of McConnell and Bruce (1992) An internal labor market is
an administrative unit, such as a manufacturing plant, within which the pricing and
allocation of labor is governed by a set of administrative rules and procedures rather
than by economic variables.

Reasons for the Existence of Internal Labor Markets

In large firms hiring and training are so costly activities that firms can minimize by
reducing the turnover of workers. The job on which the recruit is assigned requires some
sort of peculiar skills or a teamwork ability to operate effectively. Such skills and
abilities are developed through specific trainings in which on the job-trainings are
foremost. By designing attractive mechanisms the employer must retain such a
specifically skilled workers in order to reap a return on such investments and minimize
costs. Employers make use of the job ladders mechanism to retain trained workers over
a period of time. The functioning of internal labor market system is advantageous for
the employers as well as the workers.

§ Advantages internal labor markets to employers

- Increasing the return the firm received on its investments in specific
- Reducing the amount and cost of specific training offered to the worker

- Reducing recruitment and screening costs and the chances of making
emors in filling jobs due to lack of information about the recruit.
- The existence of disciplined, productive and continuously motivated work
§ Advantages of internal labor markets to workers
- Enhancing job security and built-in opportunities for job training and promote
- Being shielded from the competition in the external labor market
- Being protected from favoritism and capricious managerial decisions
through the formalization and codification of the rules and procedures
- Enjoying proper process and equitable treatment with respect to layoffs,
promotion and access to training opportunities.

Some Points about Internal Labor Markets

1. Labor Allocation and wage structures
As the definition of the internal labor market indicates administrative rules and
procedures rather than market forces determine the labor allocation or the promotion
process. The typical administrative rules underlie seniority as the basis of promotion,
i.e. a worker with the longest period of service is given priority to be promoted to the
next ladder of the job. Experience rather than ability matters in labor allocations
Likewise, firing of workers tends to focus in the newly recruited workers.

Wage structures are not also determined by the market forces, instead administrative
rules; customs and tradition are used to establish the wage rate. Job evaluation, which
is a procedure by which jobs are ranked and wage rates assigned in terms of a set of job
characteristics and worker traits, is a system used by the administrators. Using jobs
instead of workers as the basis for wage rate determination blurred productivity
differences among workers in the internal labor market.

2. The Efficiency Issue

The question whether internal labor markets are efficient is open for argument, between
orthodox wage and internal labor market theorists. The orthodox economists argue that
the most efficient way of resource combination is inevitably achieved if the market
forces come into play in the competitive environment. In the internal labor market
system, workers are protected from competition, wages are determined on the basis of
job evaluation systems set by the administrative rules and procedures, and labor
allocations are undertaken on the basis of seniority regardless of its ability. The
implication of all these characteristics of the labor market is that they stand against
allocative efficiency concept from the society’s point of view.

The proponents of internal labor market theorists disprove the justification given above
by arguing that internal labor markets efficiently allocate labor because
1. There provide the employer with abundant information in the quality of the

worker that minimizes the risk of promoting the unproductive worker while hiring
workers from the external sector has the risk of obtaining the unproductive
worker because of the limited information.
2. Even though using seniority, as a single criterion for promotion is not supported
it helps select the suitable candidates. In many instance the worker’s requisite
ability and acceptable performance records are taken into account
3. internal labor markets promote dynamic efficiency rather than static efficiency.
Static efficiency refers to the efficient combination of labor and resources of
given quality. Dynamic efficiency refers to increasing productive efficiency
resulting from improvements in the quality of labor and other resources. Put
differently, the gain from using existing skills of workers more efficiently is a
one-shot gain, while the gains from improving worker knowledge and skills can
go on indefinitely. They also create conducive environment for senior workers to
share their knowledge and skills with fellow workers.

5-4 The Theory of Labor Market Segmentation

Segmentation theory, interchangeably the dual labor market theory, deals with the two
distinct types of market that exist in the internal labor market: primary and secondary
markets. This section starts with the formal definition of primary and secondary
markets, and proceeds with identifying the sources and barriers of dual labor market

5.4.1 Definitions
-primary labor markets are where the good jobs are. Primary labor market jobs are
generally characterized by
§ employment stability and job security
§ high and rising wage rates
§ the presence of job ladders , that is, good and clearly defined opportunity for
occupational advancement
§ the use of relatively advanced, capital-intensive technologies and the presence
of efficient management
§ the presence of a strong and effective labor union
- Secondary labor markets embody bad jobs and have the opposite characteristics of
primary labor markets, including
§ unstable employment and high turnover of workers
§ low and relatively stagnant wage rates
§ dead-end jobs-job ladders are nonexistent or severely restricted
§ relatively primitive and labor-intensive production technology
§ absence of unions and archaic and capricious managerial practices
It is work adding that the characteristics that exist in the primary and secondary labor

markets are supportive and reinforcing within the market. Put differently, a
characteristic in, for example, primary labor market entails or results in another
characteristic. We should bear in mind that the two markets can co-exist in the same
organization; for example, a surgeon and an orderly can work in the same hospital.
Behavioral Patterns and worker traits
Primary labor Markets Secondary Labor Markets
§ stable employment
§ high rate of turnover
§ reliable behavior
§ stable work habits
§ regular report for work § poor habits of work
§ punctual
§ conscientious handling of equipments
§ weak job attachment
& materials
§ adherence to rules & procedures
§ absenteeism, tardiness
§ anxious to learn new skills

5.4.2 Sources of Dualism

Here the explanation center on the reasons why the primary and secondary markets
exist simultaneously. The simultaneous existence of the dual markets is justified in
terms of the following two sources.

1. Industry structure
The degrees of production variability in the product market influence the firm’s demand
in the labor market, being a derived demand. The stronger the industrial structure of a
given firm the smaller the degrees of production variability that the firm faces, and the
more stable for the firm’s employment. Seasonal and climatic factors and business
cycle fluctuations are responsible and the potential causes of production variability.
Firms engaged in a seasonal or climatic sensitive production activities are more likely to
face instable demand for their products and to seek casual workers for their unstable
jobs in the secondary labor markets.

Another explanation for the dichotomization of labor markets, as Galbaraith explained it,
stems from the dichotomization in the business sector into planning and market
sectors. The planning sector, consisting of giant corporations and possessing some
degree of monopoly powers, are characterized by barriers of entry, capital-intensive
techniques of production, large economies of scale, high-rates of profit rising
productivity and real wages, high demand for skilled labors, and aggressive use of
advertisement and other forms promotion mechanisms. As they are planning for
long-tern growth and scarcity they are not subject to uncertainties in the product market,

rather their product markets, both domestic and foreign, are stable, and thus their
demand for labor also stable.

Quite a number of small firms and farmers form the market sector. This sector is
characterized by strong completion, few economies of scale, and relatively primitive
technological level consequently, these firms face uncertainties in the product market
and their demand for labor is not as stable as the planning sector’s.

2. Monitoring and Efficiency wages:

Economists argue that firms encourage work efforts by either mentioning their workers
closely to avoid shirking at work or increasing their wages and pursuing other policies
that enable workers to highly value their jobs. Firms having a lot of workers and jobs
demanding high responsibility, large firms need to assign a great deal of money for
monitoring purpose. Implementing high efficiency wage mechanism and clearly
defined job ladders is preferred to the costly monitoring strategy to minimize the cost of
eliciting work effort. Such strategies are features of the primary labor market. In
contrast, the smaller the number of employers, the cheaper the cost of monitoring will
be, and the lower the importance of the efficiency wage strategy will be. These are the
characteristics of secondary labor markets.

5.4.3 Barriers to Mobility

According to the dualists, it is believed that there is mobility with in the primary and
secondary labor markets but little mobility between them. Several factors are given as
possible reasons for blocking the mobility
(a) The established rules and customs about discrimination:
Workers are institutionally discriminated by race, sex and ethnic background.
Many blacks, women and illegal immigrants are compelled to search for jobs in
the second labor markets.
(b) Employer’s perception about the worker’s history
If a worker has experienced the secondary labor market, he is believed to acquire
bad work habits, and no specific skills and is likely to be regarded as an
inferior:, Law-status or unreliable worker. So there is hardly any chance to
join the primary labor markets.
(c) The role of technological and economic growth
Economic and technological progress more contributes for the enhancement of
the average skill level for the primary labor markets than for the secondary labor
markets. Jobs in the secondary labor market are not characterized by such a
specific skill that the skill gap between the two markets is increasingly growing.

6.1. Human Capital Theory
The variation in wages is ascribed to variations in the jobs workers are assigned.
Different jobs obviously entail specific set of abilities and acquired skills, or human
capital, which are acquired from schools and through formal and informal on the job
trainings. When workers are thinking of their earnings over the working life they need to
contemplate about the set of skills they acquire and are ready to offer for the employer.
Put differently, the decision of how much to earn in the evolving working life depends on
the decision of what kind of skill to acquire. To this and investments in schooling
constitutes and important element.

Investments in schooling, however, involves costs of sacrificing earnings today and fees
and other educational expenditures in exchange for the higher rewards to be collected in
the future time. According to the values people place on future returns from today’s
investment in schooling, some keep on attending schooling while others drop out at
some stage Therefore trade-offs b/n today’s long one earnings and the higher earnings
in the future, together with access to Learning and training opportunities determine the
distribution of educational attainment in the population. If some group of the population
is constrained by financial and institutional Clements, their access to education will be

limited and hence remarkable differences in educational attainment are likely to happen
between sex, racial and ethnic groups. Differences in educational status, in turn, are
reflected in differences in the labor market outcomes-labor force participation rates,
unemployment rates and wage rates. Usually labor force participation and wage rates
are positively correlated with education

6.1.1 Basic Model of Human Capital

The concept of present value underlies model of human capital. Any investment
decision compares costs and benefits of different time periods, using the widely used
technique of present value. This technique helps us compare the amount of money
spent and received in different time period. The formula to calculate the present value
(PV) is given by

where y is the amount of money either to be received or to be paid next year and r is the
rate of discount.
Because Birr 200 today is different from Birr 2100 next year, to know the present value
of next year’s Birr 100, we need to discount Birr 100 by some rate of discount. So the
present value of next year’s Birr 100 tells us how much we should invest today so as to
obtain Birr 100 next year simple manipulation give the result of Birr 90.91 if the rate of
discount assumes a value of 10%.

Likewise, receiving Birr Y n Years from now has the present value of

Having said so much as to how calculate the present value, we, first, identify the factors
that affect workers’ decision to attend different levels of schooling, and next, apply the
present value notation to determine the highest level of schooling to be attended.

To identify the factor that influence a person’s decision about education consider a
student who has just completed his high-school education level at 18 years of age. This
student encounters with two options: the first option is to join the labor market and the
second one is to remain in school and attend his college education for the years to
come. To simplify matters suppose that there is no no-the-job training and the skills
acquired in schooling do not depreciate over time, implying that the worker’s
productivity, and hence real wage, remains constant under the first option. Suppose also
that the person remains in the job until he turns 65. To illustrate the earnings difference
between a high school and college graduates, we can use the age-earnings profile as in
figurer of as. Under the first option where the student leaves school after completing

high school and joins the labor market, he/she acquires a relatively lower skills level and
earns a relatively low wage rate that remains constant through out his working life, WHS
in Figure 6-1. While the student was in the high school assume that he/she faces no
schooling fee of any kind.
The second option states that the student chooses to keep on his schooling. While
attending college, he insures two types of costs; direct cost, the cost incurred to cover
tuition, books and fees, and forgone earnings, as the student stays out of work while
attending school. The fang one earnings, WHS is equal to the sum of the earnings a high
school graduate could otherwise have received for the years he goes to college. After
graduation, at the age of 22, the person earns WCOL real wage until retirement.

Earnings (Birr)

WCOL Earnings Difference

(Gross Benefits of attending college)
Earnings Age
18 22 65
Direct of worker
Cos -H

Fig 6.1:Potential earning streams faced by a high school graduate

Note that the earnings stream of a high school graduate is kept constant when he is 18
years of age and he turns 65, WHS. But his earning at the age of 18 is not the same as
that at the age of 65 from today’s point of view. So the present value of the earnings
stream, discounted at r%, is given as

Likewise the earnings stream of a college graduate that is received starting from the
age of 22 to 65 is given by a constant value of WCOL. But, in order to earn this income
level the student needs to incur a schooling cost of H for the first four years of his/her
life cycle. The present value of these costs and earnings stream, discounted at r % , is

The contrast between the present values of high school and college earnings firms the
basis of schooling decision. A rational decision of schooling tends to maximize the
present value of lifetime earnings. If the present value of lifetime earnings resulting from
colleges education, PCOL, is greater than that resulting from high school education, PHS,


the person should decide to attend college rather than enter the labor force.

It is worth considering that, the rate of discount plays an important role in choosing
whether to leave school or go to college.
Some Points about the Discount Rate
§ The higher the rate of discount, that is when the person attaches a lower value to
future earnings opportunities, the less likely a worker will invest in education
§ A rate of discount is sometimes approximated by the market interest rate
§ A rate of discount reflects out time preferences between the consumption given
up today and the rewards to be received in future-high discount rate refers to
present oriented approach
§ Little is known about low people’s time orientation is determined

The Wage-Schooling Locus

The preceding discussion helps us make a decision of going to school or entering
the labor market on a subjective basis. This is because the present value concept
employed to select the skill level that maximizes lifetime earnings depends on the
subjective rate of discount. Therefore the present value calculation related with the
schooling decision varies from present to person.
To avoid such subjective evaluation of schooling decision, the problem can be
approached form a stopping rule notation. The alternative concept helps to
identify the optimal time at which the person stops and enter the labor market and
suggests the way for estimating the rate of return to education. The wage-schooling
locus, which associates the salary that a particular worker would earn and the
employer would be willing to pay if he completed a particular level of schooling,
constitutes the analytical tool for stopping rule. The salary for each schooling level
is determined by the supply of workers with that particular schooling and the
demand by employers for workers with that schooling level.
Properties of Wage-schooling locus
(i) It is an upward sloping curve:
Financial rewards must tend to motivate educational decisions so that
additional cost incurred to improve skills must be accompanied by more
(ii) The slope of the locus tells us by how much a worker’s earnings would
increase if he were to obtain one more year of schooling. In short it is closely
related with the empirical measure of the rate of return
(iii) The locus has a concave shape
The Law of diminishing marginal returns is applicable to human capital
accumulation, i.e. as schooling level increases by one unit the extra benefit
from each additional year of schooling decreases





W0 ∆S
S0 S1 S2 Schooling
Fig. 6-2 The wage- Schooling Locus

The Marginal Rate of Return to Schooling

The marginal rate of return to schooling, which is a more closely related concept to
work- schooling locus, measures the percentage change in earnings resulting from one
more year of school.

where is the slope of the wage- schooling locus. To see the definition of MRR
more closely, suppose that the cost incurred in attending school is given by the forgone
earnings. A high school graduate earns W0 if he joins the labor force, W1 if he joins the
labor force after a year and so on. If he avoids labor market entry by a year he will forge
W0 earnings. The worker’s one-year investment in education, however, raises his
earnings by So, the marginal rate of return to schooling compares this
additional earnings resulting from additional investment in education with the foregone
The concavity of wage-schooling locus implies that the marginal rate of return schedule
is declining as the year of schooling increases.

The Stopping Rule Determination

To determine the optimal schooling level, we need to compare the MRR and the
perfectly elastic rate of discount. For every given rate of discount, r, there is a
corresponding MRR value. Present-oriented are less likely to go to college than
forward-looking people. In other words, the more present-oriented a person is, the larger
the individual’s rate if discount and the higher the likelihood to quit schooling at lower
levels. On the other hand, the marginal rate of return schedule gets lower and lower as
the years of schooling increases. The MRR and the rate of discount, r, curves are highly
likely to intersect at their lower values if the years of schooling is larger, and at their
higher values if the years of schooling is larger, and at their higher values if the years of
schooling is smaller. The intersection point of MRR and the straight-line rate of discount
determine the optimal level of schooling. For example, in Figure 6-3 S1 is the optimal
level of schooling when the rate of discount is r1.
MRR/rate of discount

R2 A

R1 S2 S1 schooling

Fig 6-3 the schooling decision

The intersection point represents the stopping rule that tells the worker when to quit

The stopping rule can be established in terms of the marginal approach. The marginal
rate of return to schooling can be regarded as the marginal benefit from each added
year of schooling. Similarly, the rate of discount which is approximated by the market
rate of interest can be regarded as the marginal cost because it would have been equal
to the rate of return had the worker quit schooling, enter the labor market and invest the
earnings in a bank . By comparing the marginal benefit and marginal cost, it is easy to
identify the optimal level of schooling that maximizes the worker’s present value of
earnings over the life cycle-stopping rule. At this level of schooling MB = MC.

If the worker quits schooling at S2 (MB>MC), hence the decision is to continue

schooling. To conclude, we can distinguish two main factors that are responsible for
differences in the levels of schooling and differences in earnings. These are the rate of
discount and the marginal rate of returns to schooling.

6-2 The Wage Gap among Workers
r, MRR Earnings

rA W2 PB

rB W1 PA

MRR Years of
Year of S1 S2
S1 S2 Schooling
Fig 6-4 Schooling and Earnings when workers have Different rates of discount.

As long as investment in education contributes to the variation in earnings differentials,

more schooling inevitably leads to having more earnings. The important question to be
answered is by how much earnings, would increase if some sort of public policy is
pursued to achieve a targeted schooling level. In other words to what extent of precision
can our model estimate the returns to schooling resulting from the implementation of
public policy. The answer depends on the presumption about the two factors that gives
rise to differences in the levels of schooling and earnings among workers.

(a) Differences in the Rotes of Discount

Under this part of underlying assumption is that workers have the same marginal rates
of return to schooling but different rates of discount as shown above in Figure 6-4 (a).
According to this illustration, there are two workers, A and B, who have different rates of
discount, rA and rB respectively. Because of the different discount rates they place on
future returns, the present-oriented worker A’s schooling level S1 is lower than the
relatively future-oriented worker B’s schooling level, S2.

As a result of such differences in the years of schooling, worker A earns fewer wages
than worker B does. According to figure 6-4 (b) worker A, with S1 years of schooling,
earns only W1, being located on point PA of the wage-schooling locus; workers B, with S2
years of schooling ends up earning W2. Being located on point PB on the same
wage-schooling locus. As both point A and point B are located on the same
wage-schooling locus, the movement from point A to point B provides us with the
estimate of the marginal rate of return to schooling, i.e. the percentage change in

earnings resulting from one more year of schooling. It is therefore possible to precisely
predict by how much the earnings would increase if the years of schooling increases
from S1 to S2.

(b) Difference in Ability

Sometimes differences in the born ability of workers may be observed leading to
differences in earnings among workers. If the two workers, A and B, are rather assumed
to have the same rate of discount, differences in the ability level gives rise to a different
wage-schooling locus between them. This in turn results in different marginal rate of
return schedule as indicated in rate of interest

rate of interest earning

r B

(a) (b)
Figure 6.5 Schooling and Earnings when Workers have different abilities
Figure 6.5(a) graphs that, given the same rate of discount, MRRA is located to the left of
MRRB, implying that worker B is amore able person than A. In figure 6-5(b) because of
differences in ability the wage-schooling locus of B lies above than of A, reflecting that

even if worker A had S2 years of schooling hew would earn only while worker B
does WB for the same . The earnings difference gap widens when there is the years of
schooling difference, located at point PA and PB. These two points trace out the line R,
making the estimation of returns to schooling difficult.
Suppose the governmt designs a policy that that enables to raise the years of schooling
of workers such as A, from S1 to S2. Such a proposed policy increases A’s earnings from

to which is still less than the earnings of worker B. The enacted policy is
not able to narrow the wage differentials however effective economic impact of the

policy. This is because the initial wage difference between the two workers happens
owing to differences in the levels of both education and ability. We can thus conclude
that the model fails to correctly estimate the rate of return to schooling when difference
in ability exists between workers.

6-3 On the Job Training (OJT)

The other component of human capital that contributes a great deal in the building of
the human stock of knowledge is on the job training. The range of training activities
varies widely across the jobs. Broadly the job leanings (OIT) are classified into general
and specific. When a sort of training, once acquired, is equally useful or equally
enhances productivity in all other firms, it is referred to as general training. Examples of
general training includes learning how to use a computer, how to drive a tractor, learning
how to demine land and trainings for a policeman on some specialty are some eases in
point for specific training A mixture of specific and general OIT are also abound.

To better understand the functioning of on-the job training, let’s use the following
simple framework in which
§ There are two periods: period 1 and period 2
§ The total labor costs in the two pervade are given by TC1and TC2
§ The values of marginal product in the two periods are given by VMP1 and VMP2
§ The rate of discount is given by
Thus, the present value of the costs associated with hiring the worker over the

two-period life cycle is

Likewise, the present value of the worker’s contribution to the firm is

As the profit-maximizing condition requires the equality between wages and the value of
marginal product, the optimal level of employment for the firm in the two-period frame
work is given by the equality between equation (6.8) and (6.5) , i.e.

Suppose also that the firm carries out OJT only in the first period and costs it H amount
of money, which includes the cost incurred to conduct the training. Then the total cost
of hiving in period one is TC1 + H and that in period 1 is W2 only because in period two no
training occurs. Equation (6.10) can be rewritten as

Having seen the simple framework for OJT, the next task is to consider who is going to
realty pay the training costs fro both general and specific OJT.

(i) Who Pays the General Training’s cost?

Receiving the training in period one, the worker acquires more skill in period two than in
period one so that the worker’s value of marginal product in period two (VMP2)is larger.
As a result, all the other firms are willing to pay this worker a higher wage rate, W2 that is
equal to VMP2 to maximize profit. Unless the firm that facilitates the training pays an
equal amount, W2 the worker will quit working in the firm and be employed in any of the
other firms. Therefore to retain the worker this firm pay W2 level of wage rate equals to
VMP2, i.e. W2 = VMP2. Equation (6.11), thus, will be reduced to

Equation (6.12) depicts that period one wage, or trainee wage , is lower than the value
of marginal product of labor during that same period, implying that the worker bears the
full cost of training. A Medical internist job is a good case in point because the internist
earns low wage and work long hours during their internship program but after the
completion of the program he/she is recorded accordingly.

What would happen if a firm was to pay for general training? Suppose that no contract
agreement is entered between the worker and the firm. While arranging this training, the
firm expected that it would not raise post training wage until the cost is covered. Once
the training is completed the worker quit the job and get employed also where. Realizing
this undesirable consequence, firms always pass on the training costs to the workers.

(ii) Who Pays the Specific Training’s Cost?

The training received in a specific firm is not so important for other firms that the
worker will face an alternative wage that depends on his reframing productivity. In other
words, the productivity gain resulting from septic training does not help the worker to
raise wage in all other firms.

Let us see what would hipper if the form or the worker paid for specific training First, if
the employer paid for this cost in the first period and didn’t raise the post training wage
regardless of the higher VM P2. The firm would gain from the excess benefit (VMP2>w2).
as long as the worker remained in the firm. Unless there is an assurance against
quitting. The firm will no be willing to incur the cost of training and collect the pay off in
the second period.

Second, if the worker paid for the specific training cost, the worker would lower wage in
the first period and higher in period two. The worker however does not have any
guarantee if he is employed and earns w2 in period two in the firm. The worker, therefore,
is not willing to pay for the specific training in the first period in case he gets laid off.

In case of no legally binding contract, neither the worker nor the employer will be willing
to undertake the specific training. Let us consider a situation in which some sort of

labor contract a bout the post training wage is centered so that the post raining wage is
less than the corresponding value of marginal product but greater than the alternative
wage, To. The alternative wage refers to the wage paid in all other forms on the basis
of retraining productivity.
< w2<vwp2------------------(6.13)

Thus established contract makes the worker as better off as the employer why is so?
Being paid a post-training wage greater than the retraining wage in the second period in
this firm, the worker is not motivated to quit job. From the employer’s point of view,
paying the worker below the value of marginal product, the employer has no incentive to
lay the worker off. So both the worker and employer share the rate of return of the
specific training. Sharing the returns of specific training entails sharing the costs of
training as proportionally as possible. It means that if the firm corers x% of the specific
training cost, it will have to share the same x% of the return.
One important implication of such a contract arrangement is that it confers the worker a
type of tenure and lifetime contract in the firm.

OJT and the Age-Earnings Profile

So far we have been dealing with the effect of specific training on the worker’s decision
when it is conducted once at the beginning. However, investment in human capital is not
demitted to as a first period activity, rather it takes place over the working life. No
matter when the investment takes place, the decision on investment is reached only
when the marginal cost equals the marginal revenue of human capital. It is worth noting
that both marginal values change as the worker gets older.
For the sake convenience, human capital stock is measured by the efficiency units
embodied in the worker. Assume that
i. The worker can rent out this efficiency unit in the labor market at a rental
price of R.per efficiency unit
ii. The market where the efficiency unit is rented out is so competitive that the
worker faces the rental rate R irrespective of the amount of efficiency he/she
has-perfectly elastic horizontal line for R.
iii. All trainings are general and the human capital stock does not depreciate
over the working life
iv. The worker enters the labor market at age 20 and plans to retire at age 65
The marginal revenue of acquiring one efficiency unit of human capital at age 20

We can illustrate the relationship between MR20 and the number of efficiency units that
the worker acquires as in Figure 6.6 below. The market being competitive, for different
losels of efficiency units the marginal revenue curve, MR20 remains horizontal.
Similarly, if the worker planned to acquire the same efficiency unit at the age of 30, the
marginal reverie of acquiring an efficiency unit would be MR30




Q30 Q20 Efficiency units

Fig 6.b The Acquisition of Human Capital over the lift cycle

Simple comparison tells us that is greater than . This is because of the fact
that the curlier the human skill is acquired, the longer the time period over which the skill
is rented out. Investments of human capital undertaken at older ages can be rented out
only for shorter periods
The amount efficiency units that can be acquired using the production function of
human capital vary over the working life. The worker acquires more efficiency units, if
he/she early invests in human capital. Accordingly the cost of production is higher at the
younger age than at the older age but because of the underlying assumption of
diminishing marginal returns the marginal cost cure has a concave shape.
At the point where the Mc curve intersects with the MR cove the optimal time of
investment in human capital occurs and the efficiency units acquired at the given age is
read at the horizontal line. For example, Q20 units of efficiency is acquired at age 20 and
Q30 units is acquired at age 30. The efficiency acquired gets fewer and fewer as the
worker gets older and older.

Age-Earnings profile
Older workers earn more than younger workers because older workers acquire fewer
efficiency units of human capital, and hence have lower forgone earnings paid for OJT.
They also earn more because they are coveting the returns made in prior investments.
The resulting Age pearling profile is an upward sloping curve (see Figure 6.7 below). As
the worker’s age increases so do his/her earnings but the latter increases at a
decreasing rate. This is because the marginal revenue of acquiring efficiency units is
declining over time.

Age-earnings profit


Fig 6.7 Age- Earnings Profit implied by Human capital Theory

6.477 Manpower Planning Techniques
Manpower planning arises from the need to relate the demand for manpower skills to
effective supply. There are two widely used techniques for such planning, namely, the
human capital and the manpower requirements approaches. While the human capital
approach focuses on the current unbalance of demand for and supply of labor the latter
does on the future imbalances.
The relationship between the demands for manpower skills to supply particularly relies
on the relationship between the human resource endowments of labor, on the one hand,
and output, on the other hand. Three linkages can be generated from this relationship
- the link between total out put produced and work force used in the production
process-labor productivity
- the link between labor’s contribution to total output and the share of total output
in the form of earnings-labor income
- the link between earnings of the work force and a measure of its human resource
endowments used in the production process-earnings distribution.
(I) The Human Capital Approach
The human resource endowments, of which relation with output underlies this approach
is measured a proxy variable of educational status, To minimize the impact of other
phenomena of the labor market on wage differentials, like sex discrimination,
experience variation and ability differences, the human capital approach makes use of
the average income. Thus changes in income earnings are mere or less ascribed to
differences in educational levels. It is worth identifying two basic implications of the
positive correlation between education levels and income earnings. Firstly, Employers
are willing to compensate the costs incurred attending schools rather than participating
in the economic activity. Secondly, persons with higher schooling level are expected to
demonstrate higher levels of productivity.

Under the human capital approach human resource development decisions are
comparable with their investment decisions in which the cost benefit criteria serves as a
basis for investment undertakings. Both benefits and costs of human capital

investments can be considered from the social and private perspectives consequently
the benefits include the potential contribution to total output and the lifetime canings
increment resulting from additional schooling. Where as the costs incorporate direct or
indirect costs incurred by the person and/or society in such investments.

Investment decisions in human capital in valves the valuation of benefits and costs on
an intertemporal considerations and is promoted only when positive outcomes are
obtained. The technique of inter temporal comparison provides the discounted or
present values of return itself can be identified as social or private.

The private net present value is calculated as the difference between a person’s income
tax after tax and direct costs (tuition, books, fee, etc) and indirect costs(forgone income
in attending school)> However, when the estimation of benefits includes income before
tax and that costs takes into account all the resources employed to offer the program,
the resulting difference measures the social net present value. The interchangeably
used term, the rates of return, refers to the specific rate at which the private social net
present value becomes zero.

(a) Estimation of the Benefits

Obtaining data on the lifetime income of a person is not such a feasible task that we need to look
for some empirical estimation method. According to Farooq (1985), an alternative approach is
followed to calculate the lifetime income from the actively observed cross section or time-series
data about the age-education profile

A cross-sectional data refers to information about individual’s income, age and educational
status at a given point in time collected through population censuses and income surveys, such
data can be further used to calculate the lifetime income of a person. If we have got a good
access of this date, we can take advantage of calculating two important concepts. Suppose the
typical person has completed his secondary education at the age of 18. Then the cross-section
data helps us measure
1. The lifetime income of the youngsters who have completed secondary education at 18 years
old. The lifetime is calculated by sorting out the observed income of persons with different ages
but only of secondary school completes. This result represents the income that the individual will
earn at the age of say 20,30,or 50.

2. the difference in expected income between those who have and have not completed
secondary education. The difference in income is thus calculated for persons whose ages are 18
and above to obtain the additional income resulting from educational differences A set of time
series data is an alternative approach from which the headlining difference attributed to
education can be obtained by cohort method. Regarding with this cohort method a
consecutive time-series data is required for each category of age and education.

(b) Estimation of costs

As economic costs of education includes both direct costs(costs borne by students their
families and training institutions) and indirect costs (production and earnings forgone). The
direct costs that involve relevant expenses (salaries way es and maintenance) and non-recurrent
capital expenditure (buildings & equipments) are mostly borne by government institutions, from
which the data about such costs is. In addition, household surveys can provide statistical

information about direct costs borne by students and their families, such as food. Clothing
housing transport, books, equipments & supplies needed for trainings.

Indirect costs, including income unearned by students, the value of tax exemptions the training
institutions enjoy, and depreciation and interest costs for the buildings, are not statistically
available rather estimated.

Criteria for Decision Making

We can use two alternative rules of selection
(i) The rule of net present value
It postulates that those projects should be selected only when the present value of benefits
exceeds the present value of costs.

Where and are the present values of benefits and costs , and are denotes the
benefits and costs corresponding to year t and are assumed to be constant throughout, and I
is the rate of discount the program is feasible if or

By taking the sum of the series benefits and costs over n horizon

(ii) the rule of the internal rate of return

Under this case those projects with the internal rate of return greater than the chosen rate of
discount will be selected. The chosen discount rate is the rate at which the present value of
benefits and costs are equal

The rule of the benefit/cost ratio postulates that in every project selected the ratio of the present
value of the benefits to the present value of costs must exceed unity. From this concept it
follows that a project will be eligible for section when

(II) The Manpower Requirements Approach

One way to link human resource planning with the sac it economic growth paths is to project the
demand for different labor skills according to the growth largest established far particular
products. Known as the manpower requirement approach, this method attempts to estimate the
demand for skills to fit determinate output growth largest and derives its importance from the

need to anticipate the labor skill shortages due to the normally long period required to train
qualified personnel. It sacks to anticipate or foresee any excesses of demand or supply with
respect to the specific skills in order to ovoid costs due to imbalances

The typical procedure is to project in a first phase, the demand according to type of occupation
(skills) for each economic sector given a target for the product known coefficients for the
amount of labor per unit of output (i.e. the inverse of labor productivity), and a certain number of
occupational categories that are supposed to be mutually exclusive. In particular, labor
productivity is projected through one of the following techniques
i. an extrapolation of the historical period
ii. the use of values obtained for an identical sector in another economy
iii. a survey recording the estimates of employers as to future changes in productivity
and corresponding mangier requirements
It should be observed however, that whatever method is used, it is possible to determine only
manpower requirements per unit of output according to different types of occupation. A second
phase is therefore necessary to translate these occupational or skill requirements into
educational/training needs. The simplest way of doing this is to apply the distribution of
occupations in each sector to the educational levels known for the base year. As additional
information, the same operation can be performed using historical parameters from an economy
with similar conditions and prospects for development. In other techniques, each type of accepts
is related to a measure of general educational development , commonly expressed by the
number of years of shoring required far the qualification level in question, or alternatively, to a
measure of specific rotational preparation , defined as the required training period.

At the risk of oversimplifying, the combinations and variations discussed above could be
grouped according to the following five basic methods
i. the opinion of the employers
ii. the incremental labor-output ratio
iii. the density quotient
iv. international comparison
v. the panes-MRP method

Method (i) relies on interviewing employers directly regarding the quantity and skill levels of
the manpower they expect to hire in the future; there is also the implicit assumption that the
figures at a national level are the sum of the projections of the individual employers. Method
(ii) consists of extrapolating the historical trend of the ratio between increases in certain
types of manpower skills and increase in the corresponding output. It is applicable only in
countries having reasonably long time series on output per worker by sector as well as labor
force by occupation and educational levels. If such time series are available only for recent
years, the method is less reliable owing to the instability of these coefficients in the short

Method (iii) estimates the proportion of manpower by given qualifications in the total labor
force for each sector of economic activity, and then applies these figures to a projection of
the total labor force in the various sectors. The method has also been applied with other
density coefficients, such as relations between different types of qualifications (e.g. doctors.
Engineers, nurses, etc) or between the target population and types of skill ( such as patients
and doctors, or pupils and teachers)

Method (iv) id characterized by the use of long series or cross-country data on the behavior
of certain parameters similar to those for the country under study during the projection
period. The pitfalls of cross-country com parsons have frequently been pointed out in so far
as they tend to over look the peculiarities of each country.
Method (v) known as the panes-MRP method, is the most widely used and combines aspects
of the other four the method follows four steps

Step 1. The target for overall production is broken down into economic sectors in varying
degrees of desegregation
Step 2. Manpower coefficients per unit of output are used which, when applied to the sect oral
tangents established, provide an estimate of manpower requirements by sector, irrespective of
occupations and skill levels
Step 3. the aforesaid projection is distributed among a certain number of mutually exclusive
occupational categories
Step 4. the occupational structure of the labor force according to sector is converted into an
educational structure by the application of standard measures of the level of formal education
required to function for each occupation.

III. Some Adjustments to the Techniques

The two manpower-planning techniques thus explained are subject to several factors other than
qualification levels. Institutional and structural factors (land tenure, exert substantial influence in
the determination of economic opportunities especially in developing carries. An equally
important factor that exerts influence in such planning techniques is the diffusion of
technological progress
Therefore, some adjustments to the two techniques discussed above are worthwhile because a
complex set of social, political, economic, institutional and technological factors determine
∙ the volume and speed with which job opportunities are being created or destroyed within
a heterogeneous labor market as a result of the level and pattern of economic growth;
∙ the vulnerability of different social groups, families or individuals to employment
problems and their credentials;
∙ the relative sharer that each worker receives in return for his contribution to total output;
∙ the attitude and behavior of the worker and his family resulting from their relative welfare

Therefore, the task of manpower planning is adjusted in such a way that

- the effect of technological change would be assimilated
- the degree and characteristics of initial imbalances in the labor market would be recognized
- the existence of inequalities among socio economic groups likely to be transmitted across
the generations would be properly considered

7.1. Employment Policy of Firms
Of the deliberate intervention in the labor marker, employment policy is the major one
that can be exercised by the government and/or the private sector. But the purpose for
which the policies conducted by these two opens will bring different out comes in the
labor market. Government policies are intended to bring about suitable levels of
employment in the national economy as a whole and in different ruffians and economic
sectors. In contrast, policies of firms are much concerned with the recruitment,
selection, training, and motivation and disciplining of workers, which influence the
nature of long-term relationship between the firm and the employees. Often policies that
fall under the second category are referred to as human resource management (HRM)

The recent tend has observed that many countries are increasingly devoting their
attention towards HRM, making the policy more important than the other groups of
labor policy. As a result of this, this aspect of the labor policy assumes a much broader
analysis than the others.

The HRM involves several stapes starting from the recruitment of to the dismissal of the
worker. The initial concern of firms contemplating to hire additional workers is the
future changes in product demand and in technology. As a derived demand, the demand
for labor depends on the nature of the product demand-permanent or temporary- In
addition the type of job the employee is expected to do is also determined by the
product demand. The duties and responsibilities of the new hives need to be well
defined in the job description or job specification that describes the education,
experiences and other qualifications of the worker.

Once the set of job specifications are defined the next task facing the firm is how to
recruit an adequate pool of applicants meeting these requirements. Recruitment. Takes
place for both internal and external workers, or from internal or external labor markets
each has its own advantages and disadvantages.

Recruiting from the internal market is advantageous because the firm is well aware of
the candidates, the workers will have incentives and the morale of workers expecting
the promotions is enhanced. On the other hand internal recruitment has some
disadvantageous in the morale of workers passed aver may be affected. Usually internal
recruitment is conducted through posting announcements, advertisements and referrals
by the employees, managers, or groups formed by minorities and women.
Recruitment from the external market is conducted through advertisement, public and
private employment agencies, educational institutions and community agencies,

employee referrals, unsolicited applications, and temporary help agencies.

(i) Advertising is one of the most common methods firms use to recruit
The advertising of such a method are that it is inexpensive, enables firms to reach a
large number of workers with a variety of backgrounds, is also helpful in ensuring a
diverse pot of applicants while the disadvantage includes the need for careful
specification of the nature of the job and the required qualifications, and the costs
involved to advertise in technical journals and community newspapers.
(ii) private and public employment agencies public agencies with the advantage
of offering cost free services for firms are dominated by low skilled clientele.
While the private agencies having the advantage of providing more attention
to high-skilled workers, demands payments for such services Note that
public agencies are obliged to give priorities for ensuring employments to the
unemployed and the disadvantaged groups
(iii) Educational institutional and community groups educational and
organizations for women and minorities sometimes serve as a good source
of interested and qualified workers for firms
(iv) Referrals from other employees to present employees are believed to
recommend candidates with high qualifications. The advantage is the
recruitment is performed freely, however, this method is not far from
problems because the present employee is likely to recommend an applicant
with similar sex race or other group. Also employee referrals of relatives can
applicant with similar sex, race or other group. Also employee referrals of
relatives can sometimes lead to difficulties of supervision.
(v) Unsolicited applications is the firms may not have vacancy when the
applicant applies for job the advantage is that sometimes applicants with
special interest and annual initiative may appear. The disadvantage is the
applicant may be engaged in other job at the moment the firm needs to
employ the candidate
(vi) Temporary help agencies it can be particularly woeful if the firm is seeking to
hire a worker for only a short time, for example, to fill in for an employee who
is on sick leave or pregnancy leave, to staff a short term project or to help
during a period of peak demand. They provide the firm with a buffer

To absorb the shocks of short-term changes in labor demand, there by creating greater
job security for the firm’s regular employees

2. Selection
One the firm has determined the job specification and recruited a pool applicants, the
next task is the selection of a worker who best fits the criteria and possesses the
requisite qualifications Decision of selection is reached on the basis of the information’s
assembled about the worker, including the application form the referrals and interviews
and teats results. Tests may be of particular skills or aptitude or personality ones. After
all, teats are preferred to have take into account the subsequent performance of the

worker. The validity of the selection device relies on the association between the test
scores and the subsequent success on the job

Among others, reference check and interviews are the most widely used selection
devices most employers check references, partly to ascertain the accuracy of
information the applicant has provided, but also to obtain additional information.
Telephone conversation with the reference person may reveal the conduct of the worker
as the reference is relatively free to say an thing about the worker. Important though it
may be the employer needs to leave some room for biases from the former employer
unless the prospective employer has confidence on the reference person.

The alternative selection device is conducting interviews. Although relatively subjective,

the interview enables decision makers to probe the applicant about questions arising
from other information sources. Interviews can also be used to assess intangible
factors such as the applicant’s motivation and his ability to fit into the work group they
must be careful, however, on to make judgments about candidates based on gender or
other strategies.
3. Orientations and Training
Once the worker suits the selection device, the next step is to introduce the new worker
to the company, to the particular work group, and to the job. The introduction can be
done informally or formally. Formal introduction in cotes conveying the general
philosophy and altitudes of the company and encouraging new workers to assimilate
into the company’s culture-hard work, following orders meeting deadlines, high quality
of output, creative problem solving, team work and continuous improvement of
production processes.

Training can be learnt formally or informally, two . Informally, the required skills for the
job can be learnt from a socialized work group, or the worker can be formally offered a
training session. It is so easy to train a new worker to fit into an ongoing productive
work group the problem is changing the established cultures of doing things. Adapting
to new technologies can be hard for some workers so the basic problem for many firms
is to develop new philosophy and culture.

According to Misname and levy, firms that succeed in continually improving their
product generally follow five common principles
1. Ensure that all front-line workers understand the problem
2. Design jobs so that all the front-line workers have both inventive and
opportunities to contribute to solutions
3. provide all front-line workers with the training needed to pursue solutions
4. measure progress on a regular basis
5. persevere and learn from mistakes there are no magic bullets

Many firms find trainings costly activities because it involves both direct costs
trainers salary and material expenses and indirect costs opportunity costs. The

opportunity costs include the extra output both the trainers and the trainees could
have produced during the training period.

Skills of some positions cannot be so quickly acquired that workers need pass
through a series of positions. A new worker starts needs to go through a job ladder
(job progression or career path) successfully before he/she assumes a high paying
position. On passing through the career path, the worker acquires relevant skills and
knowledge that enables him/her to assume responsibilities in a higher paying

4. Motivation
There are two approaches of motivation that is used to raise the productivity of
workers. The first approach is suggested by Douglas McGregor who discussed
motivation on the basis of two alternative set of assumptions theory x and theory x
holds that most people are lazy and try to avoid responsibilities such employees
must be closely supervised and threatened with punishment if they are to work
effectively to achieve the firm’s goal.

Theory y says that work is as natural as play and that the threat of punishment often
is not the most effective motivator In this view people are motivated by needs for
achievement and self-esteem, needs that they can often satisfy through employment
Under this alternative set of assumptions, most employees are creative, hard
working and willing to accept responsibility, at least if given proper encouragement.

The second approach is known as Thurow approach to motivation. He sees many

worker as social builders, as people who want to build an empire to which they can
belong and from which they can gain esteem. In recent years, there has been an
increased emphasis on work teams, especially self-directed teams there are several
reasons for this development first, and it increases the flexibility of the work group.
In addition, the team approach is likely to increase worker motivation. If the firm is
large, it may be easier for workers to develop a strong attachment to a small work
group than to the firm as a whole. If the work group is an important social group for
its members, than informal social pressure from team members can be a very
effective source of worker motivation

Because the teamwork bears fruit as trust gravities and communications are
smooth, firms should regard selection criteria from human relations and technical
skills point of view. Proactive diversity policies against racial tensions and gender
stereotypes are necessary to ensure the effective functioning of teams.

5. Total Quality Management (TQM)

Being very effective for predicting standardized goods at low pieces, mass
production system used to motivate employees by encouraging them to come work
on time to work hand and to do exactly as they were told. Starting from 1970 the
shift has accrued in many advanced economics towards the flexible production
method, emphasizing on high quality. Goods of which production method adapts the
high quality approach include consumer durables, clothes, or entertainments. The
best-known approach that emphasizes on quality product is total quality
management (TQM), pioneered by W. Edwards Deming.
The underlying assumption of TQM
1. A concern for quality must pervade the entire firm: quality must start with top
management and must be reflected consistently in their actions as well as their
2. Quality is defined in terms of the customer, what a customer needs, wants and
expects. As a result frequent feed back from the customer is an important
component of TQM
3. It is believed that most defects in output are due to systematic problems,
including faulty procedures and equipment, rather than to mistakes by individual
employees thus workers should be encouraged to help the firm improve its
procedures and equipment.
4. Quality should be built in from the start Generally it is more efficient to detect
and correct errors immediately rather than to rely on inspections of final
products, which may not detect a problem until it has already affected many
Successful implementation TQM requires
- the provision of accurate information on quality to help discover the causes of
quality problems and to develop solutions
- training workers both in technical skills required to produce quality products and
TQM skills-interpersonal communications, and statistical techniques
- forming teams and integrating them, with the aim of continuously striving to
improve quality
- compensation polices should be designed to encourage cooperation and
problem solving-paying bourses to teams that achieve specific measurable
gains in quality- and to disregard competition among individuals workers or
teams- paying on the basic of subjective assessment of merits or quantity

6. Dismissal for Cause

In spite of being replaced by TQM, the control approach, based on the assumptions
of theory x has still been practiced by some employers for ultimate sanction The
employment relationship has long been established on the basis of employment at
will principle. Under this principle the worker can quit job whenever necessary and
the employer practice the ultimate sanction, ability to fire workers, at any time
he/she wants. A caringly no third party can claim justification for the decision If
forms exercise their ability to fire workers, workers will be hurt a great deal because
of such a decision. Thus some restrictions and protection are necessary to save the
worker from uncalled for termination. Unionized workers are covered from the unfair
practice of ultimate sections through their unions; government employees are

protected by civil service legislation, and others are also protected by
anti-discrimination legislation, which prohibits firing of workers because of age, sex
race, religion and national origin.

7.2 Government and the labor Market

Government actions have substantial consequence in the operation of the labor
market. The government sector can influence the labor market in three different
aspects: public sector employment, expenditures on nonpayer spending and

7.2.1 Public sector Employment

Government is a major, even the sole, employer of specific types of workers in many
labor markets. For example it hires military personal, local and regional
administrators, doctors and nurses, school teachers, enterprise managers, extension
agents, federal policemen, agricultural experts, postal workers, etc the demand for
these workers is derived from the society’s demand for the public sector goods and
services when government employs workers, it exhausts or absorbs economic
resources . When government employs workers, it exhausts or absorbs economic
resources hat could otherwise have been used for the production of other goods and
Services presumably, society values the public sector goods or services more highly
than the alternative uses of the nation’s productive capabilities.

7.2.2 Non payroll spending by Government

This spending of the government takes two forms
(1) Government purchases of private- sector output
To run its business the government sector demands goods and services produced
by the private sector. It includes the procurement of fumitories, capital goods, taw
materials, medical supplies, transport sol vices office supplies, contract services,
computers, and stationary materials. This type of government spending creates
derived demands for specific kind of private sector workers. Any change in such
demands remotely affect wages and employment levels

(2) Transfer payments and subsidies

Payments made to social security benefits to the refried, unemployment
compensation, and welfare payments are considered as transfer payments, which
do not directly absorb or exhaust productive capabilities. The individuals and
families who receive the transfer payments from the government perform no current
productive activities in return- transfers are non exhaustive. Likewise, a subsidy is a
transfer payment to a firm institution, or household, which consumes or produces
some specific product or service. Medicare for the elderly, price supports for
farmers and public education for youth are all examples of subsidies.

By affecting the demand for specific product, for example Medicare products,

transfers alter the derived demand for specific labor, say labor that produces
medical supplies and provides medical series. Similarly subsidies provided to
private firms and NGOs also affects the derived demand for specific labor thus the
government programs on transfers and subsidies are more likely to alter the
structure of total demand in the economy. On the other hand, transfers and
subsidies affect both short-run and long run supply of labor. As both leisure and
work are normal goods, transfer payments produce an income effect induces the
recipient to put less hours on work. Also if the amount of the cash transfer is
inversely related to work income-that is if a benefit reduction are applies to earned
income-then the program creates an accompanying substitution effect which further
reduces work effort.

The influence of transfers and subsidies on long run supply can be reflected by its
effect on incentives to human capital investment. This results in a reduction in the
future benefits and consequently the long run labor supply however, some sturdy
programs education reduces the private cost of investment in human capital, like
provisioning of low interest rate loans for college students- Under this case the net
present value of such investments in human capital.

7.2.3 Income Taxation and the Labor Market

Since income from wages and salaries constitute the greatest share of national
income it is worth considering the impact of personal income tax on labor markets.
Assuming that the elasticity of labor demand is given, our interest is to bee the
effect of personal income tax on wages and employment as th4e elasticity of labor
supply varies.
Two demand curves for labor can be graphed one for the before-tax wage and
another for the after-tax wage that corresponds with alternative quantities of labor
demanded by employers. The curve that relates the after- tax wage with the quantity
of labor hour demanded lies below the other. Consequently the vertical difference
between the two demand curves measures the personal income tax per hour of work
at each particulate market wage rate (and at each particular quantity of labor
demand). This vertical distance widens as the wage rises, indicating that the tax rate
is progressive.
Given these features for the labor demand curve, let us consider the impact of
personal income tax under two settings of the labor supply curve
(a) Perfectly Inelastic Labor Supply
This indicates that workers do not collectively change the extent of their labor force
participation in response to wage rate changes (see figure 7-1 (a) below).

Wage Rate Wage Rate


D1 W3 F
W2 E A’
W2 A
W 13 C
W 12 B
Quantity of Labor

L1 L2 of labor L3 L2
(a) Perfectly Inelastic Supply (b) Upward-sloping supply
Figure 7-1 the Impact of Personal Income Tax on wages & Employment
Figure 7.1 (a) indicates that before-tax equilibrium wage and employment are W2 and L2
respectively at point A. As the personal income tax is imposed, workers perceive that for
L2 units of labor workers receive only W2, at point B. Since the supply is perfectly
inelastic, the income tax will not affect the collective quantity of labor. Therefore,
workers bear the entire burden of the tax

(b) Positively Sloped Labor Supply

This implies that people collectively increase their labor hour offerings when the wage
rises and reduce them when it falls. In the absence of income tax, the equilibrium wages
and quantity of labor at figure 7.1(b) are W2 and W2, at point A(. When personal income
tax is introduced, workers will reduce the amount of labor supplied from L2 to L3, at point
C. At the previous wage rate of W2 employers demand L2 units while workers are willing
only to supply L3 units. This will put upward pressure on the wage rate to W3, at point F.
Workers who are still working in the firm receives a before-tax wage rate of W3 rather
than W2. /after0tax wage rate of the worker, however, is W3’. Leading to a total tax
payment of W3W3 (the distance between point F and point C). Part of this tax payment of
W3W2 (the distance between point F and point E), is borne by the employers, and the
other part, W2W3’, (the distance between point E and point C) is borne by the worker.

Other things being equal, if the overall labor supply curve slopes upward, a personal
income tax will reduce the quantity of labor supplied, cause the wage rate to rise, and
decrease employment. Given the elasticity of demand, the greater the elasticity of
supply, the greater the portion of the income tax borne by employers in the form of a
higher market wage. For a perfectly elastic labor supply curve the entire tax will be borne
by employers and that the employment effect will be greater.

7.3. Job security

The nature of security for a certain job emanates from the characteristics of the job
itself. Some jobs proved employment security for long periods and explicit or implicit
assurances that one will work full weeks throughout the year. Other jobs, however, put
great stress on employers as their employment is short-Lived. Part-time employees, on
call workers, people working for subcontractors, part-time independent contractors or
consultants-contingent workforce- are characterized by variability of employment,
variability of earnings or both. People who are contingent workers may receive relatively
high compensating wage for the low probability of their work to last for the whole year.
Since temporary laid off are more recurrent for contingent workers than regular workers,
the farmer are usually engaged in pat-time work and are working in a moonlighting
basis. Most the time contingent workers are females, blacks, youngsters and students.

In order to reduce the problems associated with job insecurity, several countries impose
legislations on firms to pay a substantial amount of severance to the laid off workers.
These polities would be expected to slow down the rate at which workers are laid off. Of
course such policies tend to discourage firms to hire new workers during an economic
expansion (because firms know that it will be difficult to lay off the workers when
economic conditions worsen). Evidences support that these job security provisions have
an impact both on employment fluctuations and on labor demand. As suggested

7.4. Occupation Licensing

Economic rent, being the difference between the wage paid to a particular worker and
the wage just sufficient to keep that person in his or her present employment, underlies
occupational licensing.

As shown in Figure 7.2(a), the market wage rate, determined by the interaction of
demand and supply, is given at W0 and the resulting equilibrium employment is L0.
Although the wage rate that is sufficient to keep all the units of labor below L0, say for
example, L1, is less than W0, what is actually paid in the market is W0.

wage rate wage rate S1

D So
W2 B C
W0 C A W0 A E F


L2 Lo L3 QL

L1 L0 QL (b) Rent provision through occupational licensing

(a) Economic rent in labor markets
Figure 7.2: Economic rents with and without occupational licensing

All the units of labor with the exception of the last L0 unit receive economic rent given by
the area ABC. If government passed some law in favor of the workers so that the wage
rate would rise above W0, the economic rent of every worker, including L0 could increase.

The underlying reason why government pass such laws that entrance the economic
profits of workers is to get acceptance among these protected workers, especially
professional groups and unions. Elected officials (rent providers) keep the interests of
their constituents (rent seekers) keep the interests of their constituents (rent seekers)
by exercising occupational licensing. Accountants, auditors, architects, dentists,
lawyers, engineers, pharmacist and psychologists are examples of such rent seekers
who are highly organized to politically block the provision of rents. The practice of
licensing systems restricts entry into the occupation and keeps wages well above the
competitive level.

The rationale for occupational licensing lies in protecting consumers from irreparable
damages resulting from the incompetence of some specialists. To minimize the cost
involved with obtaining enough information about the competency level of specialists,
governmental licensing system is being used in several countries as an assurance. In
reality, however, such a proactive is more advantageous for occupational groups than
consumers by restricting entry into the occupation and number of practitioners.
Common practices of licensing procedures
1. the political pressure for licensing generally comes from those in the profession,
not from consumers
2. the licensing board, constituted from the most knowledgeable an din the best
position to judge and determine the competence level of the new entrants, is
formed from members already in the occupation, So as to restrict the supply of
practitioners and raise their earnings they tend to restrict admission into the
3. Occupation licensing generally raises the standards (requiring some educational
level or testing) for new entrants to the occupation, which ,by raising the cost of
entry, reduce the supply of applicants. Seldom are the incumbents tested to

check their updated knowledge
4. in some eases, such as medicine, the profession can restrict entry by controlling
the schools that applicants must attend to become licensed.
5. Licensing requirements often require skills that are not relevant for job
6. Licensing occurs for many occupations, such as barbering and plumbering in
which consumers are perfectly capable of judging quality for themselves

When occupational licensing is exercised the incumbents enjoy economic rents as

shown in Figure 7.2 (b). The pre-licensing equilibrium wage and employment are given
at W0 and L0 respectively, at point F. If licensing is exercised for L2 number of workers, the
wage rate rises to W2,at point C, making the labor supply curve SgS1. In case of no
licensing requirement, the total labor supply at W2 wage rate would be L3, making SS0 the
supply curve of labor. As a result of licensing of occupation, for every hour worked
licensed workers receive an economic rent of W0W2, leading to a total economic rent
given by the area ABCE. The pre-licensing total economic rent was given by the area
SAF, while the post-licensing total economic rent increases to the area SGCB, resulting a
gain in economic rent of ABCE.

Occupational licensing of this type creates an efficiency loss for society given the area
GCF. The additional L0L1 workers would have been employed in this occupation would
contribute more to the value of society’s output in this employment (as shown by
segment CF of the demand curve) than in their most productive alternative uses of time
(as shown by segment GF of the supply curve).

7.5. Incomes Policy

As unions (workers’ association aimed at improving the workers’ terms of employment)
intervene in the wage bargaining situation, it is likely that depending upon the relative
strength of the union the wage rates will be fixed well above the market-clearing rate.
Stronger labor unions are likely to adversely affect the functioning of firms, of which
profit maximization objective conflicts with the motive of trade unions, leading to
cutting jobs in the long run. To prevent the trade unions from bringing such undesirable
consequences, governments implement income policies wherever the need arises. Such
policies place a ceiling on wage growth so that the bargaining power of unions varies
between the market clearing level and this ceiling. The essential argument for incomes
policies is that they prevent trade unions from exercising their monopoly power either by
raising the employer’s resistance or by penalizing trade unions if they push for high

The success of an income policy is likely to depend on the motives, which lead trade
unions to exploit their monopoly power. One motive may be their concern over
member’s relative pay. The goal of each trade union may be to match the wage
settlement and this is subsequently imitated, the rate of nominal wage growth can be
set at a rate above that warranted by productivity growth In the absences of sufficient

growth in aggregate demand, this will result in falling employment. In these
circumstances incomes policies can take on the characteristics of a public good. They
may award equal wage settlements to all groups and thus satisfy trade union
aspirations for comparable wag increases, but achieve this at a level of nominal wage
growth which is consistent with that warranted by the rate of productivity growth. An
income policy can thus achieve the desired set of relativities without either the
unemployment or the imitation associated with the wage outcomes that might have
emerged in an unconstrained bargaining context.

Such a defense of incomes policy will not be appropriate in all circumstances. It will
depend on the circumstances, which led freely negotiated wage settlements to be
established at a non-market clearing level in the first place. Productivity will differ
between firms, and those firms which set the pattern fro the subsequent round of wage
rises were the most productive, the level of settlements that results will be appropriate
for some firms but not for others. Where the productivity performances of industries
differ, they no longer warrant a uniform level of wage settlements, and an income policy,
which enforces such a structure, is no longer desirable.

7.6 Labor Market Legislation

The labor market outcomes are amenable to a set of legislations and rules. Among
others immigration laws, anti-discrimination laws, labor relation lows, minimum-wage
law, occupational health and safety regulations are the most important and worth
considering legislations and regulations. Brief reviews of these laws and regulations
from the labor policies viewpoint are given in what follows.

7.6.1. Immigration Policy

Immigrant policies vary across nations to restrict the quantity and quality of immigrants
into that country. The implementation of this policy is justified by that most
undocumented immigrants are unskilled workers. As a result these individuals and their
families reduce employment opportunities for the existing work forces, depress wage
rates in already low-wage labor markets, and financially strain taxpayers through their
receipt of transfer payments and use of social service programs. However the
theoretical justification does not support these fears well enough.

First let us see the effect of immigration on employment. The supporters of immigration
policy argue that a given number of jobs exist in the economy, and that if one of these
positions is taken by an illegal worker, then that job is no longer available for a legal
resident. The argument against this claim is that illegal aliens only accept work which
resident workers are unwilling to perform and thus take no jobs from native workers.
However, illegal immigration does cause some substitution of illegal aliens for domestic
workers but that the amount of displacement most likely is loss than the total
employment of the illegal aliens.

The second effect is depressing the wage rate. The overall effect of illegal immigration
on the average wage rate in the economy is less clear. Some native workers and illegal
immigrants are gross complements. This means that the reduced wage rate associated
with the illegal immigration lowers production costs, creating an output effect which
results in an increased labor demand for certain native workers. Also, spending by illegal
aliens adds to the demand for products and therefore increases the derived demand for
labor. On the other hand, this impact is reduced because many illegal aliens remit large
portions of their pay to their families living abroad. We can thus conclude that
large-scale illegal immigration does reduce the wage rate for substitutable low-skilled
domestic workers. But illegal immigration probably has little net impact on the average
level of wages.

Thirdly, immigration policies are recommended to mitigate burdens on fiscal budget.

Although illegal immigrants are denied of having public assistance from social services
programs, they forge documents and qualify for such assistances. Because of their
participation in these programs, the social welfare systems are compelled to bear the
burdens. In addition, if the illegal aliens displace native-workers the latter will join the
welfare and income maintenance programs. In other words the immigrants impose
indirect costs of unemployment benefits for the uprooted low-skilled native workers. In
contrast, most illegal aliens are young workers without families who do not claim such
transfer programs even if they have families, they need to pay even if they have families,
they need to pay for using local public services slice schools, roads, and parts. They
also pay social security taxes, user fees, and other taxes

7.6.2. Anti-discrimination Policies

There are several ways of approaching the problems of discrimination. The general
policy is
1. To achieve a tight labor market through the use of appropriate monetary and
fiscal policies. On the one hand, an expanding market economy makes it
increasingly expensive for employers to indulge their tastes for discrimination.
On the other hand, thigh labor markets help to overcome stereotyping. Put
simply, over-full employment attracts more job opportunities for minorities and
2. To improve the education and training opportunities of those who have been
discriminated against. To raise the competitiveness of minorities or women it is
possible to upgrade the quantity and quality of schooling received by them.
3. To inference through government regulations of anti-discrimination that
prohibits unequal treatments in hiring, promoting, compensating and firing
workers. The last approach favors the imposition of regulations that make any
discrimination illegal. If workers perform equal work on jobs, the performance of

which requires equal skill, effort and responsibility, and which are performed
under similar conditions, then the payment among workers must be equal
irrespective of their sexual or racial differences. Sometimes the law goes further
and attempt to broaden the concept of equal pay for equal work to the notion of
equal pay for work of comparable value to a firm or government agency,
comparable worth doctrine. According to this doctrine a male construction
worker and a female nurse will receive the same pay if the two jobs are

7.6.3. Labor Relations laws

This is one way of government intervention in the labor market to influence union
membership and bargaining power. The historical background of workers’ organization
in unions showed that workers who attempted to join membership met with
discrimination discharges, and lawsuits in the early periods of the 20th century. During
this period governments and courts supported the actions of employers and disliked the
formations of unions so that low union membership was registered. With the absence of
labor relations laws, cases related to workers and employers confront were treated on
common law in interpretations. Consequently, unions were placed in a weak position in
the labor market.

The growing interest to join membership caused the enactment of a series of labor
relations laws that protected the union movement and encouraged growth of union
membership. Consequently, the costs of joining a union, like losing one’s job, reduced
over time. Unions have evolved to impose costs on firms as a way to obtain higher wage
offers. Larger union wage gains, in turn, increased the incentive for workers to become
union members.
7.6.4. Other Legislations
One of the intervention mechanisms of government into the labor market is achieved by
fixing a minimum wage of some amount. The objective of such a measure lies in that
the workers need to be secured from the declining purchasing power of lower wages
resulting from inflation. The law should also protect the low-skilled workers from the
exploitation of monopolistic employers, in which women and minorities are likely to be
affected. Apart from these, minimum wage is expected to put positive pressure on
technical efficiency, as employers are devoted in raising productivity.

Another important arch of government intervention into the labor market is the
regulation of occupational health and safety. Under such regulations government
enforces employers to part insurances to workers injured on the job. Occupational
health and safety regulation becomes important as workplaces become more
dangerous than before. In order to incidents of job injury and illness by identifying and
eliminating hazards found in the work place, occupational health and safety regulation
becomes important as workplaces become more dangerous than before. In order to
incidents of job injury and illness by identifying and eliminating hazards found in the

work place, occupational health and safety standards should be established and
enforced through inspections and fines for violations.

8.1 Employment Challenge in Developing Countries

It must be noted that for reasons related to the nature and structure of the labor market
and, perhaps more importantly, for serious data limitations, unemployment rates in
many developing countries must be considered with a great deal of caution. (It should
also be noted that these unemployment figures are often not comparable across
countries, and in a few cases even across reporting periods with in the same country.)

Although it may be difficult to discern a pattern of unemployment from the

figures in Table 8.1, They suggest increasing unemployment in many countries.

Moreover, these figures tell us nothing about the serious problem of underemployment,
which is much more prevalent. Data on underemployment are even more difficult to
obtain. However, analysis of data from a sample of countries ( Hopkins, 1983) indicates
that between 1974 and

Table 8.1: Estimate of unemployment rates for selected developing countries,

Country Labor force Percentage of labor force unemployed
1990 1970 1980 1984 1985 1986 1987 1988
Egypt 14,574 2.4 5.2 6.0 - - - -
Ethiopia 21,225 - 23.0 - - - - -
Ghana 5,686 6.0 10.0 - - - - -
Kenya 10,011 - - - - 16.5 - -
Nigeria 41,857 - - 5.7 8.3 - - -
Senegal 3,192 - 17.4 - - - - -
Somalia 2,143 - - 22.3 - - - -
Tazania 12,597 - - - 17.7 - - -
Zambia 2,644 - 27.5 - - - - -
Zimbabwe 3,921 - - 12.3 - - - -
33,398 - 38.5 11.5 11.9 12.0 - -
Indonesia 71,314 - 1.7 2.0 2.1 2.6 - -
Malaysia 7,071 - 5.6 5.8 6.9 8.3 8.2 8.1
Pakistan 33,698 - 3.5 3.9 3.9 3.7 - -
Republic of 18,664 4.5 5.2 3.8 4.0 3.8 3.1 2.5
Sri Lanka 6,367 - 13.5a - 14.1 - - -
Syria 3,101 6.4 - 5.1 - - - -
Thailand 29,534 - - 5.1 - 5.3 - -
Latin America and The Caribbean:
Argentina 11,548 - 2.6 4.6 6.1 5.2 5.9 6.3
Bolivia 2,283 - 7.1 6.9 5.8 7.0 7.2 11.5
Brazil 55,026 - 6.2 7.1 5.3 3.6 3.7 3.8
Chile 4,753 - 11.7 18.5 17.0 13.1 11.9 10.0
Colombia 10,394 - 9.7 13.4 14.1 13.8 11.7 11.1
Ecuador 3,287 - 5.7 10.5 10.4 10.7 7.2 7.4
Guatemala 2,628 - 2.2 9.1 12.0 14.2 12.1 9.6
Jamaica 1,246 - 13.8 12.1 12.5 10.9 8.6 8.7
Mexico 30,487 - 4.5 5.7 4.4 4.3 3.9 3.5
Peru 7,138 - 7.1 8.9 10.1 5.4 4.8 7.9
Venezuela 6,860 - 6.6 14.3 14.3 12.1 9.9 7.9

a b c
1981 Estimate . 1983 Estimate . 1982 Estimate
Source: (i) Labor force data are from ILO (1986)
(ii) Estimated unemployment rates are as reported by the respective
Governments; compiled at the ILO (Credit: J.Jimenez, Employment
and Development Department).
1982 underemployment increased in all developing regions except Asia. The
unemployment situation in many Latin American and Sub -Saharan African countries
has become worse, as noted earlier, as a result of economic crises and the deflationary
and retrenchment policies implemented under structural adjustment programmes. In the
light of the general prospects for economic growth in the majority of developing
countries as outlined in Section B, the situation is not likely to get much better in the
next few years, especially if investment rates in these countries persist at the current
low levels.

To illustrate the dimensions of the employment challenge, consider a country where

labor force is growing at the rate of 3 percent per annum and where employment
elasticity relative to output growth (i.e the percentage increase in employment for each
percentage increase in GNP) is 0.5.7 To keep the rate of unemployment at the same
level, employment must also grow at 3 percent per annum. This will require a GNP
growth rate of 6 per cent, which is much higher than the growth rates observed in most
developing countries during the 1980s. Now, to obtain a GNP growth rate of 6 per cent
requires a net investment of 18 per cent, assuming a marginal capital out put ratio of 3
to 1, which should be considered on the low side. Few low income developing countries
can afford net saving rates higher than 10 percent; for example, reported net savings as
a percentage of GNP in 1986 are 9.4 for India, 11.9 for Thailand, 7.0 for the Philippines,
and 3.9 for Rwanda (UN, 1990b). And it must be understood that these are the
requirements for merely maintaining the status quo, and that merely will be needed if
conditions are to be improved.

Economic growth does not, however, result automatically in the generation of new jobs
or in improvements in the quality of employment. While recent growth in several Asian
countries and in the United States has been associated with some job creation, in many
countries elsewhere (for example, Western Europe) growth has been fuelled largely by
increases in labor productivity and has had little effect on employment (ILO, 1989a).
Differences in employment elasticities may partially reflect, beyond relative factor
prices, the degree of flexibility of the labor market, for example the extent to which
regulations imposed in the interest of human rights, social justice and minimum labor
standards favour or inhibit job creation, or the ease with which retrenched workers (e.g.
following structural adjustment programmes) can find and adapt to new occupations. It
also reflects the factor combinations that are selected or prioritized for new productive
ventures (e.g . whether a particular line of production should be labor - or capital-

The challenge facing the developing countries is reduction of current labor

underutilization to levels that will minimize poverty and inequality and to ensure that the

large number of expected new entrants into the labor force find remunerative
employment. This is certainly a formidable task, but it is by no means an impossible
one, at least if in addition to strategies aimed at expanding the demand for labor, action
is taken now on the supply side through serious population polices and programmes
aimed at ensuring that future population numbers do not exceed the current baseline
projections mentioned in section A. An adequate response to this challenge would also
include making choices relating to macro issues such as economic policy management,
wage policy and the sectoral composition of growth, and to micro issues like labor
market flexibility and job security, education, training and retraining, and assistance in
finding work (ILO, 1989a).

8.2. Concepts And Measurement Issues

A thorough familiarity with the concepts and working definitions of labor force
participation and labor underutilization, and with their varied measurement problems, is
crucial to a proper analysis of the labor market and employment situation, especially in
developing countries. The reader should be aware that the concept of labor force was
developed essentially in the context of industrialized market economies where the
notion of work participation has, for a large segment of the economy, a clear cut
meaning. In a regular labor market situation, the classification of persons according to
whether or not they are in the labor force, or according to whether they are currently
employed or not employed, is therefore fairly straightforward. Such is largely not the
case in developing countries characterized by dominant agricultural and informal
sectors, where most labor activity is performed outside the contractual, organized mode
of work participation. The distinction between work and non-work, and between being
fully employed and not being fully employed, is thus problematic in many cases.

This chapter provides an introduction to various concepts of labor activity and to the
major problems encountered in the measurement of the labor force. It also deals with
labor underutilization land a number of approaches to determining its extent and nature.

A. Labor Force Concepts

1. Population of Working age and potential labour supply
In theory, all persons who are physically and mentally capable of work may be thought
of as belonging to the potential labour supply. Young children (of say above age five)
and old persons (above age 75, for instance) can be called up on and are often able to
perform some economic activity (see section B.1 for a definition of economic activity).
However, most countries set minimum age limits in their definition of the working
population, often in accordance with the provisions of several international labour
conventions ratified by many member states of the international labour organization.
Child labour (i.e. labour furnished by persons aged under 15) is officially discouraged in
almost all countries, in recognition of the fact that the use of school-age children in
economic activity yields only short-term benefits while imposing long-term social
psychological and sometimes even physiological disadvantages. Ceteris paribus, a child

provided with an adequate education will, in time, prove to be a much more useful and
productive worker than if he or she were illiterate. He or she is also likely to develop into
a more socially responsible citizen. Hence, many developing countries have launched
compulsory primary education programmes and most population censuses do not
enumerate economic activity below some minimum age. In a comparative study of
about 40 countries, which undertake labor force surveys on a periodic basis, all were
found to set a minimum age limit varying between 6 and 16 years, and most of them had
a minimum within the 12 to 14 years range1. At the upper end, elderly persons in many
societies retire from the labor force, usually in their late 50s or early-to-mid 60s.
Consequently, for practical purposes, the population of working age ( or the actual
potential labor supply) is usually defined to include only persons aged between the
minimum legal age at leaving school and the maximum legal age at retirement, hence
usually between ages 15 and 64 ( between ages 15 and 59 in some countries, and
between 10 and 59 in others). Nevertheless, an upper age limit is usually not defined in
labor force surveys.

2. Dependency burden
As a concept, the dependency burden or ratio is the inverse of the potential labour
supply. Calculated as the ratio of children under age 15 and persons 65 years and over
to the number between ages 15 to 64, the dependency ratio provides a crude measure
of the proportion of the population which may be considered as dependent ( on persons
in working ages) in the sense that they are consumers but not ( current potential )
producers of income. It is useful to break the dependency ratio into two components as
(a) Child dependency, i.e. the ratio of children under age 15 to persons in the
15-64 age group. This is a crude indicator of the dependency load on the
adults in terms of the care, support, upbringing and education cost of
(b) Old age dependency, which is the ratio of the age group 65 years and
over to that of 15-64 years.

Largely as a consequence of their high birth rates, populations in developing countries

tend to have markedly higher child dependency than those in the developed countries.
For example, in 1980 the child dependency ratio was estimated to be twice as high in
the developing countries as in the developed countries ( 69.6 percent versus 35.3
percent), as shown in Table 8.2. In contrast, old age dependency is much higher in
developed countries, (1980 estimate: 17.6 elderly persons per 100 working age adults,
compared to 7.1 percent in developing countries). As reflected in Table 8.2, population
ageing, which results from both continuing decline in fertility rates and an increase in
the life expectancy of elderly persons, is becoming a major problem in developed
countries. The overall dependency ratio is , however, currently (1990) estimated to be
substantially higher in the developing countries

Table 8.2: Age structure of population and dependency ratios by major areas,
1980-2000(medium variant)
Percentage of population Dependency ratios
Area Year Total <15 15-64 65 Total1 Child Old-age
Years Years Years dependency dependency
World 198 100.0 35.2 58.9 5.9 69.9 59.9 10.1
0 100.0 32.3 61.5 6.2 62.7 52.6 10.1
199 100.0 31.3 61.9 6.8 61.5 50.6 10.9
Developed 198 100.0 23.1 65.4 11.5 53.0 35.3 17.6
regions 0 100.0 21.4 66.5 12.1 50.3 32.1 18.2
199 100.0 20.1 66.2 13.7 51.1 30.4 20.7
Developed 198 100.0 39.4 56.6 4.0 76.7 69.6 7.1
regions 0 100.0 35.6 60.0 4.4 66.7 59.3 7.4
199 100.0 34.2 60.8 5.0 64.5 56.3 8.3
Africa 198 100.0 45.0 52.0 3.0 92.4 86.5 5.9
0 100.0 44.3 52.6 3.1 90.1 84.2 5.9
Southern 198 100.0 40.1 56.1 3.8 78.3 71.5 6.8
Asia 0 100.0 36.6 58.9 4.5 69.8 62.1 7.6
Western 198 100.0 42.1 53.9 4.0 85.5 78.1 7.4
Asia 0 100.0 38.8 57.0 4.2 75.4 68.1 7.4
Latin 198 100.0 39.2 56.5 4.3 77.0 69.4 7.6
America 0 100.0 32.8 61.9 5.3 61.6 53.0 8.6
a. Dependent age group under 15 years and 65 years and above per 100 of
population 15-64 years.
b. Dependent age group under15 years per 100 of population 15-64 years.
c. Dependent age group 65 years and above per 100 population 15-64 years.

Source: UN (1989a).
than in the developed countries (67 per cent as against 50 per cent). The
dependency load is highest for Africa, which has almost one dependent for every
person in the working ages, followed by West Asia.

The estimated and projected patterns of dependency burden in developing countries

over the period 1980-2000 bear negatively on the development effort in two major
ways. First, ceteris paribus, a high dependency ratio signifies that these economies
are having to sustain themselves on output or income produced by a relatively small
proportion of the population. Second, because the dependency burden is primarily in
the form of child dependency, a relatively larger proportion of investments, as
compared to the developed countries, needs to be devoted to social capital such as
schools and hospitals rather than to physical capital for persons in the labour force.
Moreover, the young age structure of the populations of developing countries, as
reflected in Table 8.2, Signals continuing tremendous increases in their potential
labour supplies in the decades to come.

3. Economically active populations or labour force

The crude measures of dependency discussed above serve only as first

approximations in an analysis of the economics of population age structure. Not all
persons in the dependent ages of under 15 or 65 years and above are dependent in
the sense of not taking part in economic activity. By the same token not all persons
belonging to the population of working age engage in economic activity, as reflected
clearly by Figure 3.1 which presents graphs of labour force participation rates ( see
below for definition) for developed and developing countries by age and sex. A large
proportion of young people of secondary school and college age continue with their
studies beyond the level of compulsory education. Housewives or home makers
often devote themselves full time to the fulfillment of domestic responsibilities, in
many instances leaving and re-entering the labour force a number of times during
their lifetime, so that in some countries the distribution of female labour force
participation by age is bi-modal. Moreover, in many societies, social and cultural
norms traditionally hamper female participation in economic activities outside their
homes. A part from these cases, many men may serve in the army which though
regarded as an economic activity, has a special character and is often excluded
from the coverage of surveys. Furthermore, some persons retire from employment
before reaching the normal retirement age of 60 or 65 years.

The magnitude of labour force participation depends on the definition of economic

activity or labour force that is used. The economically active population may be
regarded as comprising "all persons of either sex who furnish the supply of labour
for the production of economic goods and services as defined by the United Nations
Systems of national accounts and balances during a specified time -reference

period" (ILO,1988a:49). It comprises of persons who are working ( the employed) as
well as those who don't have work and are looking for one (i.e. . unemployed.)

The thirteenth ICLS (international conference of labour Statisticians), held in October

1982, recommended two measures of the economically active population: the
usually active population measured "In relation to a long reference period such as a
year" and the currently active population measured "in relation to a short reference
period such as one week or one day" (ILO, 1988a: 49) . The currently active
population is also referred to as the labour force.

The concept of usually active population is of particular interest in situations where data
reflecting the dominant pattern of activity is required and where the pattern of activities
is primarily seasonal in character, especially if repeated measurements cannot be made
during the same one year period. A reference period of one year is indicated if seasonal
agriculture constitutes an important aspect of economic activity (Rao and Mehran,

The population not economically active can be similarly characterized as "not currently
active" or as " not usually active." The population not currently active " comprises all
persons not employed or unemployed during the brief reference period and hence not
currently active" (Rao and Mehran, 1990:70). It is equivalent to the concept of persons
not in the labour force. In contrast, lthe population not usually active " Comprises all
persons whose main activity status during the longer specified period was neither
employed nor unemployed" (Rao and Mehran, 1990:71). The distinction allows usually
inactive persons such as students, home -makers and retirees to be considered as
currently active if they had been engaged in an economic activity, however minor, during
the brief reference period in question.

The Concept of labour force obviously describes a non-homogeneous entity made up of

groups that are themselves heterogeneous. In demographic terms the most important
category of the labour force consists of males aged 20 to 59. In nearly all societies,
irrespective of the level of development or industrialization, members of this group are
expected to engage in economic activities.
In second place is a category made up of three special groups:
(i) Young persons aged below 20 years,
(ii) Women aged 20-59 , and
(iii) Older persons aged 60 years and above.
These groups are special because the extent of their labour activity varies widely across
societies and is influenced by a complex of local social, cultural and economic factors.
Women constitute the largest group in this category, and their participation in the labour
force has been increasing in many countries over the last few decades. However, as
discussed below in section B. 3, a number of conceptual and enumeration problems
cause women's work to be underestimated in many developing countries. Of the other
two groups, labour force participation among young persons typically declines with
increasing industrialization and income levels, and the elderly tend to withdraw from the

work force at an earlier age. This can be seen from a comparison of labour force
participation rates ( LFPRs, see below for explanation) between developed and
developing countries, as in Figure 8.1
2. Note that whereas priority is given to work in the measurement of the
currently active population, the fact that one did work during the
reference period does not imply automatic classification as usually
active, the criterion in this case being main activity based on major time,
see sections B.1 and B.2 below.
Another category is that of migrant workers. In some countries, for example in
parts of Europe and the Middle East, migrant workers form an important proportion of
the labour force.

Labour force participation or activity rates

Several indicators may be used to measure the extent of participation in economic
activities. The crude labour force participation rate ( or crude activity rate) refers to the
ratio of the total labour force to the total population. This ratio does not, however,
provide a precise indication of the extent of participation, the denominator includes, for
instance, persons aged under 15 who are not in the population of working age and yet
constitute, in developing countries with rapid population growth, between 40 and 50
percent of the total population. A more appropriate measure would thus relate the
labour force to the population above the legal minimum age. Further refinements could
be obtained by excluding, as well, persons aged above the maximum legal age at
retirement. However, the most refined participation indicators are obtained by
calculating age-specific activity rates ( or age-specific labour force participation rates,
LFPRs) further differentiated according to sex. Age specific LFPRs refer to the ratio of
the labour force of a given age or age group to the total population of the same age or
age group.
For illustration, Figure 8.1 presents, in graphical form estimates of 1985 age and sex
specific LFPRs for developed and developing countries. Quite distinct patterns of LFPRs
can be discened. Male LFPRs in age groups 20 to 59 years are more or less uniformly
high in both the developed and the developing countries. Within each group of countries,
the male activity rates are higher than the female rates for every age group, partly
reflecting the tradition based expectation that males, if not attending school, enter the
labour force as soon

Figure 8.1: Estimated age -specific labour force participation rates (%) by sex, in more
developed (MDC) and less developed (LDC) Countries, 1985

Source: Based on data from ILO (1986: Vol.V, pp. 17-21).

As possible and remain economically active as long as their families depend up on their
labour activity for livelihood. The developing countries differ greatly from the developed
ones in LFPRs among three special groups. For each sex, LFPRs in developing countries
for young and elderly persons are substantially higher than the corresponding rates in
the developed countries, for reasons discussed earlier. In contrast, the rates for females
aged between 20 and 59 years are lower in the developing countries. It is interesting to
note that even though the male LFPRs are higher in developing countries for all age
groups, the male crude labour force participation rate is higher in the developed
countries -58 percent as against 56 percent in the developing countries. This is due to
the young age structure of the population of developing countries, as noted before.
Indeed, when children under 10 are excluded, the refined total LFPR ( males aged 10
yeers and over ) is 69.1 percent for developed countries, compared to 74.7 percent for
the developing countries. Nevertheless, even if only populations of working age are
being compared, it is still possible for all age specific LFPRs in one population to be
higher than those in the other and yet the total rate be smaller because of differences in
age structure.

Distinction between the employed and the unemployed

It is important to differentiate between members of the economically active population
who are employed and those who are unemployed. The latter refers to persons who are
available for work but are not employed and are seeking work for pay or profit during a
specific reference period. Evidently and in contrast, employed persons include all those
who are at work or who have jobs or enterprises during the reference period. They fall
into two main categories which, in the case of multiple jobholders, are not necessarily
mutually exclusive; those in paid employment ("employees", that is, wage and salary
earners) and those who are self employed ( employers, own account workers, members
of producer's cooperatives and unpaid family workers; see Rao and Mehran,

Types of employment based on duration
Several types of employment can be identified, according to the length of time over
which the work is carried out or is available.
¨ Full time employment is usually defined in terms of a normal or conventional
number of hours of work per week. Although 40 hours a week is still the norm
for wage employment in many countries and industries, there have been
movements toward shorter working weeks (usually 35-38 hours). In general,
hours of work that are not substantially below the norm are considered full
¨ Part time employment arises from employment arrangements (or contracts)
which specify that the employee should work a number of hours below the
legal, conventional or customary norm for the establishment concerned.
Quantitative limits are usually set. For instance, in some countries the number
of hours of work must be at least 20 percent the norm before the employment
can be considered as being part time ( Thurman and Trah, 1990).
¨ Temporary employment " Includes all non permanent types of employment
undertaken by paid employee or self-employed persons" ( definition used in
Italy, cited by Meulders and plasman, 1989:28; it would be essential to specify
what is a " non-permanent" employment, which in this case should mean one
that lasts for only a short period of time). Temporary employment includes
fixed term, interim, casual and seasonal employment, all of which are defined
¨ Fixed term employment is characterized by the existence of an agreement
between the employer and the employee that " the end of a period of
employment will be determined by objective criteria such as the passage of a
certain period of time or the completion of a task" ( Meulders and plasman,
¨ Interim employment is usually provided by an employment agency who hires
out the services of persons to establishments according to their temporary
needs. This type of employment has been growing fast in recent years,
particularly in the developed countries, but the fraction of the work force in this
kind of employment remains relatively small.
¨ Casual employment "is temporary employment characterized by its irregular
nature" ( Meulders and Plasman, 1989:55). Under casual employment,
employees are called to work according to the current labour needs of the
¨ Seasonal employment is " a type of temporary employment characterized by its
periodic availability in connection with sectors' cycles of activity" ( Meulders
and Plasman, 1989:52). Seasonal workers are often contracted for short
periods, in many cases for a few days ( PREALC,1990).
Note that casual, interim, seasonal and temporary workers usually work shorter
hours over the year but are not necessarily part time workers in the usual sense
(unless they work shorter hours during their periods of employment); see Thurman
and Trah (1990) for a discussion of ambiguities between part time and similar
kinds of employment.

Type of activity
It is important to classify members of the labour force according to work
characteristics in terms of occupation, industry and status in employment, using
internationally recognized classifications:

Occupation refers to the type of work done by the individual in a given job, e.g.
farmer, typist or truck driver, irrespective of the branch of economic activity or
status. There are, of course, thousands of occupations in the world today. To
simplify enumeration and analysis, it is usually useful to group them into
categories and subcategories. The most recent international classification of
occupations, the international standard classification of occupations 1988 (
ISCO-88),for instance, is made up of 10 major groups, subdivided into 28 sub major
groups, 116 minor groups, and 390 unit groups, as shown in Table 8.3. Under the
ISCO-88 scheme, occupations are grouped together largely on the basis of skill
requirements, so that, for instant, the "Professionals" category is associated with
the highest skill level, and the "Elementary occupations" Category, the lowest; for
details, see ILO (1990b).

Table 8.3 International Standard Classification of Occupations 1988 (ISCO-88):

major groups and sub groups
Major groups Sub major Minor Unit
groups groups groups
1. Legislators, senior officials and managers 3 8 33
2. Professionals 4 18 55
3. Technicians and associate professionals 4 21 73
4. Clerks 21 7 23
5. Services workers and shop and market 2 9 23
sales workers
6. Skilled agricultural and fishery workers 2 6 17
7. Craft and related trades workers 4 16 70
8. Plant and machine operators and 3 20 70
9. Elementary occupations 3 10 25
10 Armed forces 1 1 1
Totals 28 116 390
Source: ILO (1990b: table 1)

Industry (or branch of economic activity) refers to the activity of the establishment
or enterprise in which the individual works (e.g. agriculture or manufacturing), and
is defined on the basis of the product or out put of the establishment or enterprise.
Industries are usually grouped according to sector. Thus the agricultural sector
comprises agriculture, forestry, fishing, animal husbandry and hunting; the industry
sector: manufacturing, mining, construction, transport and communications,

utilities; and the service sector; government services, trade, tourism, banking and
finance, insurance, etc. It should be noted that the industry in which a person works
is not determined by the actual duties he or she performs. A person may be a truck
driver ( in Table 8.3, major group 8: plant and machine operators and assemblers)
working for a commercial vegetable farm ( agriculture). As in the case of
occupation, economic activity is usually classified into a number of categories and
subcategories. There are, for instance, 17 major categories made up of 60
divisions, 159 groups and 292 classes in the most recent international standard
industrial classification of All economic activities (ISIC-88) ; see hussmanns et al.
(1990:162-165), Status in employment refers to the individual's position in relation
to other workers, if any, in the enterprise and includes the categories of employer,
own -account worker, employee, unpaid family worker, and member of a producers'
co-operative.6 statistics on status are useful for understanding the degree of
attachment and involvement of different categories of workers in the labour
market. It is important to note, however, that the welfare and independence of
individuals with in the same status classification can vary greatly according to the
particular circumstances of work as possible and remain economically active as
long as their families depend up on their labour activity for livelihood. The
developing countries differ greatly from the developed ones in LFPRs among three
special groups. For each sex, LFPRs in developing countries for young and elderly
persons are substantially higher than the corresponding rates in the developed
countries, for reasons discussed earlier. In contrast, the rates for females aged
between 20 and 59 years are lower in the developing countries. It is interesting to
note that even though the male LFPRs are higher in developing countries for all age
groups, the male crude labour force participation rate is higher in the developed
countries -58 percent as against 56 percent in the developing countries. This is due
to the young age structure of the population of developing countries, as noted
before, indeed, when children under 10 are excluded, the refined total LFPR ( males
aged 10 years and over) is 69.1 percent for developed countries, compared to 74.7
percent for the developing countries. Nevertheless, even if only populations of
working age are being compared, it is still possible for all age specific LFPRs in
one population to be higher than those in the other and yet the total rate be smaller
because of differences in age structure. Factors determining LFPRs are dealt with
in Chapter IV.

8.3. Nature and Structure of Employment in Developing Countries

Employment in the developing countries has a number of distinctive characteristics,
some of which are of particular, significance to the subject of this chapter. These relate
to the extent of self-employment, the predominance of informal work relationships, the
growing importance of the informal sector, the industrial distribution of the work force,
and the phenomenon of lab our market segmentation. These characteristics are
discussed in the following sections.

1. Degree of self-employment

Developing countries are typically characterized by large proportions of the
labour force being found in the self-employed category(employers, own-account
workers, members of producer co-operatives and paid family workers; see
Chapter III, section A.3). According to the latest ILO estimates, this proportion
ranges from 45 per cent in sub-Saharan Africa to 34 per cent in Asia (excluding
Japan), Latin America and the Caribbean, and 21 percent in North Africa and the
Middle East as compared to 15 per cent in the OECD countries (ILO, 1990a:table
2). Much of this employment is in the agricultural sector; self employment
represents 52 per cent of total agricultural employment in sub-Saharan arica,49
per cent in Asia (excluding Japan),48 per cent in Latin America and the
Caribbean, 43 per cent in North Africa and the Middle East, and 51 per cent in the
OECD countries. In all regions of the world the majority of self-employed persons
excluding up aid family workers-are men. The estimated female shares in
self-employment in the agricultural and in the non-agricultural sectors are,
respectively,28 per cent and 30 per cent in sub-Saharan Africa,14 per cent and 23
per cent in Asia, 6 per cent and 30 per cent in Latin America and the Caribbean,
and 16 per cent and 25 per cent in the OECD countries (ibid., table 3). In most
developing countries (outside of North Africa and the Middle East, which have
the lowest levels of female self-employment) self-employment among females
tend to be relatively high-over 30 per cent of the self-employed -in trade,
restaurants and manufacturing (ILO, 1990a).

On the whole, the proportion of the labour force in self-employment decreases

with modernization, economic development and increasing per capita
income(ibid.; Loutfi,1991). However, this decline occurs almost entirely with in
the non-agricultural sector; as suggested by the available evidence, no such
negative association exists with respect to agricultural employment. whereas in
the non-agricultural sector the expansion of markets and the shifts to
capital-intensive products and to large-scale production, with usually accompany
development, draw workers away from self-employment, historical and
sericulture factors relating largely to systems of land tenure allow the
maintenance of a high degree of self-employment in agriculture. The degree of
agricultural self-employment is affected by agrarian strain and land redistribution
policies and practices, such as concentration of ownership (ILO, 1990a; Loutfi,
1991. The historical decline, with development, of self-employment relative to
wage employment is partly due to the decline in the contribution of agriculture to
GDP relative to the industry and service sectors.

2. Importance of the urban informal sector

As a consequence of urbanization and rapid growth of the urban force (which
has far surpassed the potential for employment creation by the large-scale or
organized manufacturing sectors, especially in the wake of the decline in the
employment elasticity of output witnessed in many countries- e,g. in south
and southeast Asia- and the declining potential of public services in

increasing employment given the lack of finance- especially in Latin America
and sub-Saharan Africa). jobs in many developing countries have
increasingly had to come from the urban informal sector. There was a
substantial rise in informal-sector employment in sub-Saharan Africa and in
the Latin American and Caribbean countries in the 1980s; in the second half
of the decade, informal-sector jobs accounted for over 60 per cent of urban
employment in sub-Saharan Africa (ILO, 1989b: table 1.13), and about 30 per
cent in Latin America (PREALC, 1990; see also ECLAC, 1989). The sector is
similarly large in the other developing regions. For example, in the major
urban centers of south and southeast Asia, micro-enterprises (including the
self -employed),most of them in the informal sector, contribute between one-
half and two-half and two-thirds of total employment (Amjad and Edgren,

The label informal sector is normally applied to small, mostly unregistered

enterprises usually consisting of an own- account worker with very few pais
employees-if any - or with unpaid family workers. These enterprises tend to
be located in urban areas and to be involved in small-scale manufacturing.
artisanal activities such as carpentry, metalwork and vehicle repair,
construction, sewing and shoe-making, transportation, commerce (generally
petty retail trade) and other service activities. Although" formal sector"
enterprises may be involved in the same kind of activities, they tend to be
considerably bigger (public services, medium to large manufacturing,
commercial and service establishments, etc), have comparatively easy
access to modern technology and credit and marketing facilities, and display
higher labour productivity and earnings. An important characteristic of the
informal sector in many countries is the absence of government regulation
(Tokman, 1991).

3. Informal work relationships

The phenomenon of informal work relationships, predominant in labor markets in
developing countries, relates especially to paid employment (including
employment for payment in kind, which is not uncommon in the agricultural
sector). It is partly the result of the influence of the large self-employment sector,
especially small, usually family-based enterprises with few or no regular paid
employees. The majority of workers tend to be either working owners of
unincorporated businesses or providers of unpaid labour to family enterprises,
mainly in the urban informal and rural sectors, where it may often be difficult to
distinguish between market and non-market production activities. Under such
circumstances it is difficult to quantify labour demand or to relate it to economic
output. Even where wage employment in the informal sector is registering
growth, e.g . in a number of Latin American and African countries, the work
arrangements and conditions of service remain insufficiently formalized,
employment and income guarantees remain well below those found in the

relatively small modern sector, and between output and labour demand may not
be as clear-cut as it is in the formal sector.

4. Sectoral distribution of employment

Agricultural employment, though declining in relative terms (and, in many cases,
in absolute terms), continues to be significant in developing countries. Table 8.3
shows the distribution of the economically active population by three major
industrial sectors (agriculture, industry and services) for major regions of the
world between 1995 and 1985. If we assume that this cross-sectional picture of
employment structure reflects economic evolution of the various regions
reasonably well, then it is evident that the proportion of the labour force which is
employed in the agricultural sector declines with economic development.
Moreover, in all the regions the trend over the 20-year period has been a
decline in agricultural employment relative to non-agricultural employment.
Among developing countries both the industry sector and the service sector have
gained in importance, but in the developed countries, especially in the
industrialized market economies, it is largely in the developed countries,
especially in the industrialized market economies, it is largely in the service
sector that employment has expanded. In fact, the proportion of the labour force
employed in the industry sector and the service have gained in importance, but in
the developed countries, especially in the industrialized market economies, it is
largely in the service sector that employment has expanded. In fact, the
proportion of the labour force employed in the industry sector in many OECD
countries has declined slightly over the period. This is partly because industrial
establishments are sub-contracting out more and more of their service sector
functions such as information services (ILO 1988b), but also partly because of
the continuation of the structural transformation process, this time away from
industry towards the service sector, as illustrated, for instance, by the decline of
certain "traditional" industries which used to employ large numbers of workers,
such as textiles.

Table 8.4: Percentage distribution of the economically active population by

sector, 1965, 1975 and 1985.
Agriculture Industry Services
Region/country 1965 1975 1985 1965 1975 1985 1965 1975 9185
World 58 53 49 19 20 22 24 27 30
Developed countries 23 15 10 36 37 36 41 48 53
Developing countries 73 68 63 11 14 16 16 18 21
Africa 76 72 66 9 11 13 15 18 21
North Africa 56 46 37 16 21 27 28 33 36
Sub-Saharan Africa 82 78 73 6 8 9 11 14 17
The pacific 69 60 52 11 14 18 21 25 31
China 81 76 72 8 12 16 11 12 12
West Asia 62 50 39 17 21 25 22 29 37

Latin America and the 44 36 28 22 25 27 34 39 45
South America 41 33 25 23 25 27 36 41 48
Central America 52 43 36 20 24 29 28 33 35
Caribbean 47 39 32 19 21 21 34 40 46

Source: ILO (1988:table A.2).

Overall, a majority of the economically active persons who leave the agricultural sector
enter the service sector rather than the industry sector. This result is confirmed by
analysis of both historical data relating to today’s developed countries, and
contemporary (cross sectional )data on developing countries (see syrguin, 1988). The
relative decline in agricultural employment is associated with a similar decline in the
relative contribution of agriculture to GDP. For example the share of agriculture in GDP
among developing countries decreased from 31 per cent in 1960 to 17 per cent in 1980,
while those of the industry and service increased from 30 to 39 per and from 39 to 44
per cent respectively, over the same period (ILO, 1984: table 1.1).

5. Labour market segmentation

In a non-segmented market, labour mobility across industries, regions and branches of

economic activity operates to minimize wage differentials. Hence, the significant
differences, which exist in developing countries in wages and in work conditions
between the rural sector, the urban informal sector and the modern sector - at times
such differences exist even between sub-sectors - underline the fact that labour market
segmentation is a major distinctive characteristic of employment in these countries. A
host of factors limit mobility in a segmented labour market. On the supply side, unequal
access to education and training facilities, In particular, means that many job-seekers
lack the necessary skills for modern sector employment. Demand side reasons are,
however, more important. These include: the elitist development of powerful enclaves of
relatively advanced modern technology (witch require highly-skilled labour) alongside
firms using simpler, labour-intensive production techniques; unrealistic pricing of
factors of production (including relatively cheap capital and inflexible wage structures)
which often encourages higher modern-sector capital-output ratios than would result
from an efficient use of factors based on relative factor endowments; high levels of
differentiation in jobs and skills; tradition-based gender-related division of labour; a lack
of flow of information about market conditions; and government policies relating to
public sector wages - which, because the government is usually the largest
modern-sector employer, often sets the pace for modern sector wages - and to
minimum wages and similar social protection measures that are difficult to enforce in
the non-modern sectors(see, for instance, Rempel and House, 1978; standing, 1982).

In a non-segmented labour market it is possible to envision a theoretical model under

which aggregate labour demand is obtained as the sum of the individual demand curves
of all the production units (according to an appropriate definition of economic activity).

Such a model makes much less sense in a segmented market, where each segment is,
in effect, a different labour market with its own aggregate supply and demand curves,
with little or no interactions between these different markets.

As an illustration, consider the labour supply and demand curves shown in Figure 8.2
below. The two demand curves D1 and D2 could be considered as two different
industries, sectors or localities, while the supply curves S1 and S2 represent groups of
individuals with different skills or training. Take, for example, workers in the group
represented by s1. In spite of having similar abilities, qualifications and perhaps even
performing similar functions, these individuals receive different wages (the differential
equals w3-w1) depending on the industry or sector in which they work. At times they
might work in the same sector or even the same establishment and yet receive different
salaries for similar work because they belong to different sexes. Such a wage
differential is the result of labour market segmentation. In contrast, the industry or
sector represented by D2 maintains a genuine wage

Differential equal to W2-W3 based on differences in skills or training of its employees.

While such a wage differential does not result from labour market segmentation, it
might become perpetuated and reinforce segmentation in the face of persistent
inequalities in access to education and training.

8.4. Policy Issues And Considerations For Developing Countries

A. Causes of the Employment Gap
The extent of the employment problem facing most developing countries was previously
outlined. Simply put, growth in the demand for labour has been lagging behind the
increase in labour supply for several decades now, and the resulting high levels of
unemployment and underemployment could well worsen in the future with continuation
of high labour force growth rates in the developing countries. As previously noted, the
factors responsible for the employment problem are mainly demographic and economic
in nature. These are summarized below.

1. Demographic and related factors
Demographic factors, especially rapid population growth, represent the most important
source of the massive current and projected increases in the labour force in developing
countries and hence, arguably, the most important cause of the employment problem. It
is evident that steady decline in mortality accompanied by stable or only slowly
declining fertility and the resulting unprecedented growth in population and young
population age structure are the main causes of the observed and expected huge
growth in the labour force. Thus the labour force of the developing countries increased
by some 26 per cent (about 300 million) between 1970 and 1980, and by another 26 per
cent (over 360 million) between 1980 and 1990. Labour force growth is expected to
construe to be high in the developing countries over the next several decades, while it
continues to decline among developed countries.

The employment problems caused by rapid population growth are amplified by the
effects of the fairly rapid expansion in educational enrolments occurring in virtually all
developing countries. In many cases, demographic and educational expansion has
resulted in the release of very large numbers of educated you youths, with high
aspirations for urban modern-sector employment, onto the labour market. This often
affects the sect oral supply of lab our and adds, for instance, to problems of high urban
unemployment and underemployment caused by migration to urban areas for
employment given the wide and persistent urban-rural wage differentials. The problem
is, of course, one of the content of education and training, not their expansion.

The observed massive rural-to-urban migration in many developing countries has, in

many cases, resulted in the doubling (at least) of the already high(natural)Population
growth rates in urban areas. Given that a high proportion of these migrants are of
working age, this implies even much higher labour force growth rates in large urban
areas. The effect has been the swelling of the urban informal sector which account for a
major proportion of urban employment in all the developing regions.

Another socio-demographic factor responsible for force growth is the increasing labour
force participation by women. Observed increases in female labour force participation
rates in some countries may simply be due to changes in the definition of economic
activity rather than real changes in the growth or composition of the labour force. In
many cases, however, there might be real, positive labour force growth because of
factors such as: commercialization of many goods and services formerly produced
predominantly for own- consumption, as part of increased monetization of the economy;
modernization breaking traditional barriers to women's engagement in labour activity;
greater opportunities for education/training for women; economic necessity to work if
the other members of the household lose their jobs under structural adjustment
programmers, or economic difficulties make one salary insufficient for meeting
household needs; etc. It might be noted that increased female labour force participation,
while contributing to the selling of the labour force in the short run, is likely to lead
ultimately to fertility decline and hence to a slow-down in labour force growth (see Fargo

and DeGraff, 1988:34-5).

The rapid growth of the informal sector in many developing countries testifies to the
fact that in these countries the modern sector cannot expand fast enough to generate
a sufficient number of new jobs. If the labour force of a country is growing at the
average developing country rate of 2 per cent annum, and if the non-agricultural
sectors currently employ 37 per cent of the total labour force, then employment in
these sectors would have to expand initially at an annual rate of 5.4 per cent if they
were to absorb ll the net additions to the labour force. Considerably greater rates of
expansion will be required in the large number of countries in Africa and south Asia
where labour force growth rates far exceed 2 per cent and larger proportions of the
labour force are employed in the agricultural sector. Very few countries have ever
experienced sustained growth in non- agricultural employment of 4 per cent.

2. Economic factors and policies

The major economic factors, policies and practices usually held accountable by
development economist as having contributed to the employment problem are
examined below.
Growth-oriented development strategy
For several decades following World War II, a common development strategy among
developing countries was to concentrate on the growth of gross national product (GNP),
with the assumption that this would automatically generate a sufficient quantity of jobs
for new entrants into the labour market. The naivety of this strategy became apparent in
a number of countries when the employment gap continued to expand despite in a
number of countries when the employment gap continued to expand despite modest to
large increases in the GNP growth rate. It is easy to see that, depending on the mode of
production, the same growth rate of GNP may be associated with very different
employment growth rates in different countries. Indeed, it is sometimes possible that
transferring from labour-intensive to capital-intensive production techniques may
reduce the existing employment level while increasing output.

The growth-oriented strategy can also have an unfavorable effect on income

distribution. As discussed before, an inequitable income distribution may be associated
with lower consumer demand for the sorts of production that generate domestic jobs.
Of course, it is also important to note the poverty aspects of income inequality.

Industrialization policy
The efforts of many developing countries to establish a relatively modern industrial
sector as the key sector in economic development has often failed to produce optimum
results in terms of the number of jobs created, due to its promotion of capital intensive
production techniques and large-scale industries.

Production techniques
The growth oriented development strategy and the kind of capital intensive
industrialization policy described above have often been associated with government
policies which lower the price of capital relative to labour, thus leading to the adoption
of production techniques ill-suited to the factor endowments of most developing
countries. This pattern has occurred not only in industry, but also in some cases in

Policies relating to exports

Because the demand for labour is a function of, among other things, the overall level of
demand for goods and services, levels of employment much higher than those made
possible by domestic demand alone can be attained by developing a vibrant export
sector. Japan and the newly industrializing countries (NICs) of Southeast Asia, for
instance, have attained enviable levels of employment and income growth by taking full
advantage of export opportunities. In contrast, many other countries which paid little
attention to the export sector or pursued policies that undermined it (e.g. over valued
exchange rates, economically harmful tax and tariff systems, etc. ) have remained poor.

It must be noted, though, that ambitious strategies that depend largely on export led
growth may entail dangers. Under such strategies, export industries are sometimes
viewed as the major vehicle for rapid modernization, and a high proportion of resources
channeled into the production of goods for which there might be relatively limited
domestic demand. This policy leaves an economic productive base that is highly
vulnerable to disruptive shocks in the international economy and can lead to an unstable
domestic employment situation. Consequently, it is important that a good balance be
sought between production for exports and production for domestic consumption. This
balance should depend, inter alia, on the nature of export markets.

It is equally important, in choosing products for export development, to ensure that

adequate links are created between export industries and the remainder of the domestic
economy. Otherwise growth in the export-oriented sector will not necessarily translate
into growth for the economy as a whole. On the contrary, it may lead to dualistic
development, which contributes to the problem of income inequality. This is particularly
true for the agricultural sector, where the introduction and expansion of production for
export may promote large scale mechanized farming which tends to displace labour
and encourage inequality in land distribution as well as cause shifts in production
patterns away from basic foodstuffs for local consumption.

Factor pricing and factor proportions

Factor pricing plays a crucial role in the choice of technology and organization of
production, and hence in determining factor proportions. We have seen that artificially
low interest rates, duty free capital imports and wage controls maintaining high wages
in some sectors act as incentives for inefficient production methods. Note that some
non wage labour protection measures ( such as those which increase the cost of laying

off workers) can raise the cost of labour relative to capital in excess of the level which
relative factor endowments would lead us to expect. These policies lead to capital
underutilization and often have the unintended effect of reducing the number of jobs
created in the economy.

Labour market segmentation

The phenomenon of labour market segmentation prevailing in developing countries
does non-only tend to create and preserve inequalities in income distribution, but also
limits the growth of productive employment. This happens through the promotion of
capital-intensive methods of production in the modern sector, and through the resulting
lack of investible resources and other inputs for expansion in the informal sector which,
along with agriculture, becomes excessively labour intensive.

Structural adjustment policies

Many governments, especially in Africa, have been undertaking structural adjustment
programmes in cooperation with the World Bank and the international monetary fund.
Several of the policies implemented under these programmes encompass many of the
aforementioned issues, largely with the intention of deregulating the economy and
reducing the size of aforementioned issues, largely with the intention of deregulating the
economy and reducing the size of the public sector. While these measures have had the
effect of correcting factor and product price distortions and overvalued exchange rates,
and creating a more favorable environment for private initiative, the short-to medium
term effects on employment in most cases have been negative. Hence, there is a need
for developing and implementing suitable measures and programmes for retraining and
redeployment of retrenched workers. It may also be added that, in general, there is a
need for careful monitoring of the impact of structural adjustment on unemployment,
incomes and the condition of vulnerable groups, and for designing and formulating
macro and sectoral polices aimed at employment and income generation for the
relatively weaker sections of the society.

Other Policies
In addition to those mentioned above, many other policies undertaken by governments
with regard to education, population distribution, income distribution, fiscal
expenditures, and international trade have had varied and sometimes important effects
on employment generation.

B. Supply side considerations

Projections of labour force size and growth rates are based on assumptions relating , in
particular, to expected trends in population growth and in labour force participation.
Most population specialists agree that population growth rates will eventually decline to
sustainable levels throughout the world. The main unknown relates to the size and pace
of the decline, which depends on trends in fertility, mortality and migration, and which
will determine the ultimate size of the population and the labour force.

A basic issue in development planning is whether attempts should be made at

influencing demographic phenomena and other determinants of labour force size and
growth, or whether a laissez-faire approach whereby the underlying variables are
allowed to evolve "naturally" should be adopted, attempts being made only to
accommodate their effects on the demand for employment. The latter approach has,
however, very few supporters among development planners today ( see Farooq and
MacKellar, 1990). Indeed, following the success of population-influencing strategies and
programmes in many countries in Asia and Latin America since the mid 1960s,
international efforts aimed at slowing down population growth in other developing
countries have been increasing.

1. Rationale for population intervention

The basis of intervention in the population area, or at least of making allowance for the
effects of population factors in the planning process, is not limited to the (considerable)
implications of population growth and distribution for labour force size and growth
alone. Population growth and changes in population structure and in its spatial
distribution affect the demand for goods and services, including the demand for
education and health by particular population subgroups. More importantly, it may
affect the supply of goods and services through its impact on savings. Other things
being equal, slower rates of population growth will result in faster increases in per
capital income. Because the income elasticity of savings ( the ratio of the proportionate
change in savings to the proportionate change in income) is often greater than unity in
many developing countries, a faster growth in per capital income is likely to result in
higher growth rates in the savings ratio and in the total volume of household savings (
UN, 1989b). In any case, changes in the age structure of the population result in changes
in dependency ratios, which may affect the rate of savings. In addition, changes in
population growth rates may affect the proportion of investible resources needed for
maintaining social services at existing per capital levels, as opposed to investments for
improving those per capital levels and for developing the human resources and physical
infrastructure necessary for economic growth and development.

The effect of population growth on land may be quite different, although the former's
impact on capital accumulation as outlined above is valid for all sectors of the
economy. Increases in the number of farming households may result in smaller holdings
and/or shorter fallow periods, overgrazing and other conditions which reduce yields and
create environmental degradation. But, on the other hand, increased pressure on land
may, in some cases and given the right conditions, stimulate the development of
improved inputs, farming techniques and infrastructure and the diffusion of other land
augmenting technologies indeed, such productivity improvements explain the
accommodation of fairly rapid population growth over the last two centuries in today's
developed countries.

Demographic change typically occurs at different rates with in different population

subgroups. Educated urban residents, for instance, tend to experience declines in
fertility and mortality before the other population subgroups. The resulting changes in
differentials of dependency ratios contribute to the widening of in equalities in

standards of living. Because the better off population subgroups tend to own a
disproportionate share of non-labour factors of production, these inequalities may be
further reinforced by declines in real wages relative to the returns to the other factors if
rapid labour force growth continues (UN, 1989b).

There may be many other justifications for seeking to influence the evolution of
demographic outcomes. The benefits of well-conceived and implemented population
and development programmes in areas such as mortality and morbidity reduction and
improvement in the status and living conditions of women could be considerable. In
relation to employment, programmes which also succeed in slowing down the
demographic component of labour force growth are crucial for many developing
countries if their employment problem were not to get out of control. There may also be
environmental and natural resource use considerations for seeking to influence
population growth, movements and concentrations.

2. Instruments of population intervention

Evidence is growing about the demographic consequences of socio-economic change.
For example, education (especially for women), urbanization and concomitant factors
such as "modern" type occupations and increased incomes, are associated with
declines in fertility and infant/child morality in many developing countries; see, for
instance, Farooq and DeGraff (1988). These same factors are also known to be related
to migration (Oberal, 1987). A typical laissez-faire strategy could, consequently, consist
of allowing social and economic development to shape the evolution of demographic
variables. However, it is evident from the preceding discussion that demographic
factors such as high population growth and high levels of morbidity and mortality may
have a negative impact on economic growth and development. Moreover, the
effectiveness of a laissez faire approach might depend on cultural factors, including the
nature and strength of traditional values, customs and practices.

From the standpoint of the employment problem, the orientation of a population

strategy will, of course, depend on specific national circumstances. However, whether
the strategy is aimed at influencing or accommodating population variables, important
points for consideration include the collection and improvement of demographic and
socio economic information to meet basic planning needs, and research into the
relationships between population factors and social and economic variables to permit
an adequate assessment of choices. For all the progress made so far, our knowledge of
these relationships is still limited. Moreover, as already noted, the relationships depend
also on a number of local factors.
i) Family planning policies and programmes
Family planning programmes are usually aimed at encouraging and enabling couples to
freely choose smaller families. The major instruments include: increasing and
facilitating access to contraceptives; and information, education and communication
(IEC) strategies and activities aimed at informing target groups about the benefits of
family planning ( fertility control, birth spacing), methods of family planning ( fertility

control, birth spacing), methods of family planning, etc. In developing countries, these
programmes are at times combined with material and child health programmes aimed
at reducing the usually high rates of morbidity and childhood land maternal mortality.

ii) Migration and population redistribution policies

Broadly speaking, there are two types of policies in this area: direct policies such
as restrictions on travel, resettlement programmes and bans on migration to
specific areas like large cities; and indirect ones which aim at improving
conditions in sending areas or at making alternative destinations more
attractive. Rural development programmes, land reform, price and income
support schemes for farmers, special credit schemes and administrative and
industrial decentralization are examples of indirect policies. Because they seek
to respond to the major motivations for migration among large segments of the
population, indirect policies tend to be more effective than direct ones ( Oberal,

3. Education and Human resource development policies

Education brings many benefits to the recipient and to the society at large. It opens up
greater opportunities to the school leaver for employment, income and leisure than are
generally available to an illiterate person, and contributes to better health, home
management and the capacity to cope with modern life ( Caldwell, 1979; Jones, 1990).
The sum total of such benefits accruing to individuals is a healthier and more
prosperous society, the social benefits being greater the higher the proportion of the
population, which is educated. These benefits alone constitute a sufficient justification
for extending educational opportunities to everyone.

But education is also an investment in human capital. It enables the society to

accumulate the technical, managerial and entrepreneurial skills needed for overcoming
physical, environmental and natural resource constraints to development, increasing
productivity and raising living standards. Education facilitates the creation of a labour
force capable of generating technology, developing new and innovative techniques and
/or applying them, and of adapting smoothly to the diverse changes encountered in the
process of economic development in the process of economic development. In the
words of Jones (1990:1), other things being equal, "higher quality labour contributes to
out put just as a better machine does".

The various social and economic benefits of education interact and may reinforce one
another, so that, for example, the better health and nutrition associated with education
can lead to increased productivity and incomes, which in turn permits improvements in
the quality of education. Similar relationships exist between education, fertility and
investments or between education, employment and the status of women. This
multiplication of benefits makes education the central element in human resource
development strategies.
In this respect, it would appear from the observed links between educational expansion
and the structure of occupations in most developing countries, and the aggravation of
the employment problem associated with the rapid expansion in education discussed in
section A.1, that existing systems of education are inadequate. As argued by Emmerij
and Ghai (1976; 64), "the role and responsibility of education and training systems in the
employment and income distribution problems is not so much one of estimating the
number of engineers or technicians required at a future date, but rather a question of
structure and content of education"(see also Godfrey, 1991). One problem relates to the
fact that in many developing countries, the educational system is oriented towards
meeting the needs of "the minority climbing up to the top of the educational ladder and
not to the majority which drops out well before the end of the ladder is in sight"(ibid).
The result is that not only a large proportion of the population leaves school ill-prepared
to affront the critical employment situation, but also the system raises and perpetuates
unrealistic aspirations and expectations about type of employment among the
educated. Solutions include a reallocation of resources in favor of a more complete
basic education for all, curriculum reforms which increase choices of career orientation
and facility adaptation to the "real world" environment, and integration of the formal
education system and practical training systems.

C Employment-Oriented Development
Arguably, the most basic consideration in the formulation of an integrated approach to
the employment problem concerns the fundamental objective of economic
development. in most societies, the objective I to in crease opportunities and choices
for all and improve living conditions. there are different ways of achieving development
and distributing its fruits. we have already noted the failure of the GNP-growth oriented
and income distribution policies carried out in many developing countries to bring about
tangible improvements in living conditions for the majority of the people. as noted by
edgren and muqtada (1990:14-15)
Rapid economic growth and high levels of national income can be possible
without full employment, and so also equity and full employment at low and
stagnating levels of income. But it is not possible to attain both equitable income
distribution and high levels of national income per capita without full or nearly full
employment. in theory, one can design imaginative systems for redistributing the
fruits of development even when only a small minority works, but economic and
political realities make them very difficult to use in practice. The most reliable way
of distributing the fruits of development among the people is still to enable them
to take part in producing those fruits through gainful employment and

The resulting movement towards an even in come distribution, in turn, provides

opportunities for further employment creation, a consideration which is of immense.
Importance in view of the expected continuation of high labour force growth rates.
Emmerij and Ghai (1 976:62) aptiy describe the relationship between employment
creation, the equitable income distribution it can generate and income growth, in their

observation that "for once we have an upward -spiralling circle rather than the famous
vicious one". Indeed, experience from employment missions and studies undertaken
under the ILO's world employment programme have shown that the employment
problem cannot adequately handled unless economic development is based on
comprehensive employment oriented strategies.

The starting point of an employment oriented development strategy is to recognize the

links between the employment problem, income distribution, poverty and patterns of
development. For reasons discussed earlier (high capital labour ratios brought about by
inefficient factor pricing and the choice of or dependence on inappropriate technology,
etc.) the modern large scale sector has on only filed to generate enough jogs to absorb
the growing demand for employment, but with its average incomes which tend to be
several times higher than those of the rural traditional sector, has also been one of the
drawing forces behind the growth of the low income urban informal sector. Writing
about the persistence of poverty in developing countries after two decades of rapid
economic growth, Lewis (1976) underlined the "inegalitarian nature" of growth by
arguing that growth takes place in enclaves and that, in a traditional society, it may take
a long while for its benefits to trickle down from the enclave to the traditional sectors.
indeed, instead of benefits spreading from enclaves to the rest of the economy, the
development of the enciave may altogether have a negative impact on the traditional
sectors, for a number of the reasons relating to government polices (discrimination
against traditional sectors)and the nature of the enclave(unfair competition with
traditional sectors in product and \or factor markets, failure to integrate horizontally
with traditional sectors and to make complementary exchanges with them).to a large
degree, this patter describes fairly well the development of the modern sector in many
developing countries. in such countries true development which reduces the present
high degree of poverty in the non modern sectors of the economy requires strategies
which ensure the removal of segmentation and the spread of growth beyond the
modern sector while shaping the latter as the engine of growth. this implies stimulating
the creation of income generating opportunities and productivity growth in all sectors.
the alternative of concentration on the modern sector and waiting for its benefits to
trickle down amount to" the sacrifice (of) two or three generation" (emmerij and
ghai,1976:57) .

Once such a principle has been accepted, the main areas of action within an
employment oriented development strategy include the maintenances of an
instructional and macro economic framework favorable to employment growth in all
sectors, facilitating access to productive inputs and improved technologies for all
sectors, and shaping the education and training system to make it respond better to
the employment challenge. These and related issues are examined below.

1. Institutional and macro-economic framework

Basically, the private sector investments required for employment growth cannot be
expected to be forthcoming if laws and measures relating to economic activity, such as

those regulating the acquisition and private ownership of production units and the
disposal of private income, change too frequently. Where the existing laws found to
impede growth and efficiency, there is of course a case for reform. Similarly, where the
laws are non-existent or are dated, new laws which spell out clearly the rights and
obligations of private investor might have to be pt into place, for the main objective here
is to reduce regulations _based uncertainty to the barest minimum. some countries try
to solve this problem by drawing up investment codes, although such codes are often
aimed at wooing large scale investors from abroad and may not meet the needs of
small _scale investors.

Macro economic stability requires monetary, fiscal and trade policies, which ensure
equilibrium between the level of domestic demand and the productive and export
capacity of the economy and keeps external payments in balance. Large fiscal deficits
may not fuel inflation but may result in the diversion of scarce ingestible resources from
private investment to public consumption. Similarly, rapid increases in money supply
may set off a cycle of inflation and currency deprecation which may be difficult to stop
except at great social cost as shown by the structural adjustment experiences of
several African and Latin American countries in recent years rapid growth in many
supply can be checked through credit restriction and the raising of real interest rates,
although the possible harmful effects on investment particularly in the more vulnerable
sectors of the economic, will need to be considered together with the potential positive
effect on saving and the necessary complementary measures taken.

In a general sense, the pursuit of an employment-oriented development strategy implies

that macro-economic policies adopted in response to internal disequilibria or to external
shocks should not conflict adopted with medium- and long-term employment and
anti-poverty goals. Moreover, the short-term social cost of adjustment can be minimized
through actions in areas such as social security, retraining and special employment
programmers. We will return to some of these measures presently.

2. Employment promotion
Governments have several types of instruments for mobilizing resources for
development, for example taxation, borrowing and transfers from abroad. The total
amount of resources that can be channeled in to productive investment is affected by
the level of economic activity, the level of savings, the level of consumption relative to
basic needs, interest and currency exchange rates, the size of domestic and external
debts, the efficiency factors. Issues relating to these factors will not be discussed here -
the reader is referred to, for instance, ILO (1989a) for a discussion based on a context of
structural adjustment. The discussion below is restricted to the allocation of resources
in a manner which maximizes employment generation

(i) Factor pricing
The role-played by factor price relativities in the choice of production techniques and
how much labour is used has already been noted. Exchange rate policies and incentive
structures which cheapen capital relative to labour result in production techniques
which do not reflect relative factor endowments. Unrealistically height wages, whether
due to legislation, public sector example or lab our market segmentation, have a similar
effect, discouraging lab our absorption.

An over-valued currency may not only discourage the use of cost-minimizing technology
(and thus reduce the potential lab our demand), but may also divert consumption from
domestic output to imported goods, dampen the incentive for exports, and reduce the
inflow domestic output to imported goods, dampen the incentive for exports, and
reduce the inflow of capital from abroad while increasing capital flight. In the short run
the effects of the resulting macroeconomic disequilibrium might be suppressed by
some form of import licensing and exchange control, but this only makes the
subsequent adjustment more painful. Ultimately, resort must be made to devaluation.
However, it is important to note that unless they are accompanied by supportive
measures that facilitate the reallocation of resources and factors of production,
massive devaluations may result in demand contractions and huge increases in
production costs which may have adverse long-term effects. Similarly, the need for
minimum social protection and the negative effects of low wages on productivity must
be considered when designing flexible wage measures and other policies for reducing
rigidities in the lab our market.

In comparison with exchange rate and labour market policies, factor-price distortions
arising from an incentive structure which favors capital-intensive techniques of
production may be easier to deal with. Required measures may include the removal of
duty-free concessions for capital imports, unrealistically low interest rates and special
tax concessions. However, to be effective in creating employment and reducing
production costs, such measures should be supported by the development and diffusion
of alternate technologies and increased competition in capital markets.

(ii) Specific measures in favor of the rural and informal sectors

The overhauling of the incentive structure and factor price distortions are some of the
measures, which will ensure a better balance between (large-scale) modern-sector
enterprises and small-scale production units in the urban informal and the rural
traditional sectors. Other necessary measures may include the modification of
restrictive regulations, and the removal of economically harmful high tariffs, import
quotas, etc Beyond these measures, it is essential that positive actions be undertaken
with a view to improving output, productivity and incomes outside the modern sector.

Such strategies do not necessarily imply the abandonment of the modern sector as the
leading dynamic sector of the economy. Indeed, it may be difficult to compete
effectively in international markets without due growth of the modern sector. However,

in many ways the neglect of the urban informal and rural sectors results in demand
constraints on the expansion of the modern sector- in addition to the resulting need, in
many developing countries, to spend scarce foreign exchange on food imports rather
than on capital formation. The agricultural sector, for example, is not only an important
provider of employment, but also a major supplier of basic wage goods (food) and a
major source of demand for the products of the modern sector (Ghose, 1990). The
urban informal and rural non- farm sector and also play a similarly important role. It is
thus essential that emphasis be placed on these hitherto neglected sectors of the
economy as on the modern sector.

A. Urban informal sector

Actions to benefit the informal sector will include research and development of simple,
productivity-enhancing tools and techniques and their diffusion, the establishment of
special finance and credit schemes, and the development of products suitable for
informal sector production. Active efforts should also be appropriate to create
strengthen subcontracting and exchange relationships between informal sector firms
and firms in the modern sector as well as public sector establishments. Special training
programmers aimed at improving the skill of informal sector workers are also called for
in many cases.
B. Rural sector
Similar and parallel efforts are also needed in the rural sector. In addition to the above,
high priority must be given to research and development of new varieties of high
yielding and drought- and pest- resistant crop varieties, better labor-intensive farming
practices backed up by efficient extension services, adequate storage facilities and fair
prices for farm output.

The development of the rural non-farm (RNF) sector is now recognized as an essential
part of available development strategy for developing countries, in terms of the potential
role that this sector can play in alleviating the problems of unemployment,
underemployment and poverty and in stimulating economic growth (see Oshima, 1972;
chuta and sethuraman,198, Islam, 1987; ghose,1990; and saith, 1991). The reason
appear to be quite clear. As already discussed modern-sector growth, even where it is
significant, has typically fallen short of the rate of labor force growth. With in the
agricultural sector, there dose not exist a substantial scope of exploiting additional
lands for farming and , for all the interest in labor- intensive agriculture, he labor
absorption capacity of agricultural intensification strategies appears to be limited.
Furthermore, the nature of stabilization and structural adjustment polices/ programmes
adopted is typically concretionary.

The best long-term strategy for promoting the development of the RNF sector may be
the one which according a high priority to agriculture in the allocation of public
resources / investment and to the functioning of the relative price mechanism. The
underlying empirical premise for this strategy is that the growth of rural incomes
constitutes a crucial determinant of the growth of demand for products of the RNF
sector. Similarly, although large scale rural infrastructure programmes, which are being

undertaken in many developing countries, could help create non- farm employment in
the short run (especially if they include components designed to promote non-farm
enterprises directly), the best way in which they can stimulate the non-farm sector is
through agricultural development (ILO,1991b).
Direct policies and programmes for the development of the RNF sector, which need to
be separately but simultaneously implemented with agricultural development
programmes, could include;
∙ Enterprise- development programmes aimed at promoting opportunities for
developing industrial enterprises.
∙ Cretid schemes aimed at supplying the required funding, which is found
generally to be crucial bottleneck in the development of small and medium
∙ Technology upgrading programmers aimed procuring suitable modern
technologies form abroad and/ or developing internally, and at disseminating
appropriate technology packages to small and medium establishments.
∙ Skill development or training programmers aimed at supplying basic skills in
order to met the demand for skilled workers. The nature and volume of this
demand could be expected to exchange in the context of an expanding RNF
sector (in terms of both size and types of activities / enterprises).

III Self-employment
The institutional, macro economic, trade liberalization and incentive structure reforms
discussed in the preceding sections will, in general, create favorable conditions for the
growth of productive self-employment. Indeed, a very large proportion of
self-employment units in developing countries are in the rural and the urban informal
sectors. Hence, by and large, self-employment would be encouraged by policies
designed for stimulating productivity and output growth in the rural and urban informal
sectors. IN both cases, in addition to the reform mentions here, specific measures are
needed to provide training and greater access to credit and productive inputs, facilitate
the flow of information relating to product and factor markets, and stimulate
entrepreneurship and strengthen entrepreneurial and managerial skill among both the
currently self employed and the potentially self-employed (ILO, 1990a; Lee, 1990). At
the same time unproductive, socially undesirable forms of self employed need to be

The selection of target groups for self-employment promotion involves marking choices
between , for instance, concentration incipient entrepreneurs (ILO, 1990a), who have
greater chances of success and thus have greater potential for contributing to
employment and economic growth, or on vulnerable groups who need the help most,
and risk the possibility of higher failure rates. Consideration must also be given to the
fact that special measures aimed at helping new entrants in to self-employment may
undercut existing viable self-employment by subsiding new competitors (Loutfi, 1991;
12). The major issue is, as is often the case, how limited resources should be allocated.
Related issues include the choice of promotional measures, as some may yield little in
relation to there opportunity costs. Unfortunately there are few easy and certain ways of

insuring the success of promotional strategies. And it is essential to encourage both
wage and self-employment as part of a strategy to achieve full, productive and freely
chosen employment.

3 Development of Infrastructure
The start- up and operating costs of production units and inefficiencies in there use of
resources will be high in the absence of an adequate supporting infrastructure.
Transport and telecommunications networks are needed for the rapid movement of
production inputs and out puts and the smooth functioning of production and factor
markets, relatively secure sources of energy and water must be developed for both
industrial and agricultural production, financial services have to be developed and
centers for research and training must be set-up. With out them, it is difficult for new
enterprises to be set-up, and for the existing once to expand. Hence, infrastructural
development constitutes a major preterit for employment growth.

Most poor countries find its difficult to satisfy basic current consumption needs, and a
fortiori, to set aside resources for investment in economic and social infrastructure.
However, in many cases proper planning, waste reduction and the relocation of
resources (e.g from defiance spending and prestigious but otherwise unproductive
projects. and the proper use of external funding can help establish and maintain a basic
infrastructure for sustained economic growth.

Infrastructural development should not only benefit the modern sector. A development
strategy which neglected the needs of the large proportions of the labor force usually
found in the rural and urban informal sectors can hardly experts to succeed in achieving
growth in income and employment. As pointed out by a recent ILO director- general’s
report, as a result of past neglected informal sector enterprises often operate in make
shift premises, form which they may be obliged to move at any time, in sanitary
conditions, with out access to electricity, clean water nor sanitation facilities, all of
which discourage investment (ILO, 1991a;32). For amore-balanced development, there
is thus the need to allocate more land and to provide at least simple work sheds,
market shelters, sanitary facilities and safe drinking water (ibid.), in addition to
transport and energy facilities. Such measures will, in themselves, result in
improvements in productivity. they will also encourage and enable informal sector
enterprises to obtain improved equipment and technology by providing them with
legitimacy , greater stability and access to capital and product markets .the need is
hence to extricate the informal sector from the vulnerable and situation in which it finds
itself in most developing countries .

Similarly, attention must be focused on rural sector problem such as inefficient and
inequitable land distribution, lack of reliable access roads, electricity and safe drinking
water and other facilities growth in agricultural output as well as non farm economic
activities . some of the measures required , such as the development and diffusion of
improved technologies , the provision of basic social infrastructure (roads ,

telecommunications water ,energy ,education an training facelifts ,etc and improved
access to credit, have already been mentioned . others include land reform , land
improvement schemes (including irrigation and water control ), crop storage facilities
and improved marketing networks.

It is worth noting that rural development strategies which succeed in creating

employment and income growth opportunities for the rural population can help reduce
the level of rural-to-urban migration and hence reduce the problems of urban growth to
more manageable proportions. As indicated earlier, such an approach is likely to have a
greater impact on migration than direct attempts to regulate population and labour

4. Direct employment-generation schemes

In countries where unemployment is high, there is a case for the direct mobilization of
labour on capital-formation projects in the context of an employment-oriented
development strategy. In part, this need arises from the absence of unemployment
benefits and poverty relief measures in the majority of developing countries. Direct
employment generation programmes provide unemployed persons jobs with
remuneration. At the same time such schemes, focused on labour-intensive
construction projects, can be used to meet many of the infrastructural needs discussed
in the preceding section: roads, irrigation projects, low-cost housing, clinics and school
buildings, shelter and site development for informal-sector enterprises, soil
conservation and reforestation, and reservoirs and sources of water (see Gaude etal.,
1987). In addition to providing emergency relief, they may contribute to wards
employment growth through the demand stimulated by the additional income and its
multiplier effects, and through social capital accumulation. Demand stimulation and
infrastructural development can also help the working poor, especially those in
own-account informal activities and in small-scale agriculture, to increase their

Care should be taken in the design of direct employment-generation schemes that they
are consistent with the general development and employment policy and meet minimum
labour standards. They should also be viewed as constituting only a short-term solution.

5. Disadvantaged groups
A part from measures aimed at providing emergency employment and improving
productivity and incomes in the rural sector and in the urban informal sector, it is
essential to design and implement special programmes targeted at groups that are
particularly vulnerable to poverty, unemployment and exploitation. Three such groups
deserve special attention: women, especially those outside the modern sector, the
elderly and the young. The quality of women's employment tends to be worse than that
of men. They tend to be concentrated in traditional low- productivity industries. In Asian
countries, many of them are home-based workers-working in small own-family

enterprises, under subcontracting arrangements and as piece-rate workers. These
workers are known to work long hours and receive relatively low remuneration for their
labor. Also, in many developing countries women, especially rural women and the urban
poor, shoulder a disproportionate share of the worked needed to sustain their
households. In many cases, women have seen their roles expanded and an increase in
the demands and burdens placed on them since, partly as result of male migration, the
phenomenon of female-headed households has become increasingly common. It is
important that development policies and programes result in an improvement in their
conditions and increasing the opportunities available to them to enable them to
contribute fully to the development process. Not only do they deserve this from an
equity standpoint, but survival of their families also depend on it.

In addition to increased employment opportunities, there is a need for the organization

of common facilities for childcare, family planning, food processing, laundry, etc., so
that women are relieved of the drudgery and work overload in the home.

Similar efforts are needed to provide the elderly with basic needs, including health care,
and with social protection for the portion of their lives in which they cannot work at full
capacity. The required strategies should include measures designed to reduce their
dependence on children for old- age support. Such measures may, in fact, contribute
towards the removal of one of the incentives for high fertility.

Finally, concerted efforts are needed to provide children with an adequate education
that will equip them for viable long- term careers and to minimize the exploitation of
child labour.