Labor markets provide a mechanism for employers and employees to agree on terms for exchanging labor input for wages. In accepting an employment relationship, a worker agrees to receive wages (and other inducements) in exchange for submitting to the directives of the employing organization within some zone of indifference. On the labor supply side, individuals adjust their hours of work in the labor force on the basis of changes in income, career opportunities, and other conditions of employment. On the demand side, employers adjust their engagement of labor on the basis of changes in relative prices of labor, the quality of labor, and other constraints. For labor markets to operate efficiently and effectively, mechanisms must be in place to support flexibility and adaptability to changing levels of supply and demand, while conforming to social expectations regarding equity, morality, and so forth.
Labor markets exist within the firm and external to the firm. Internal labor markets are characterized by job ladders in the firm, supported by evaluation systems that reward skill development and worker commitment. Entry to the firm occurs mostly at the bottom of the ladder, and movement up the ladder follows the development of skills. Internalized work often comes with the implicit understanding that employment is permanent, or at least long term. External labor markets, by contrast, are normally more flexible, unless they are tightly regulated by governments or constrained by the behavior of labor interest organizations. External market transactions consist of contractual relationships that specify what each party to the exchange is to deliver. The simplest form of employment contract is the spot contract in which all obligations are fulfilled on the spot, as in the case of hiring day labor without any obligations for the future. To the extent that internal labor markets produce employment stability, internalization makes it expensive and politically difficult to adjust the volume of labor to changing internal organizational and external market conditions. This is the main reason why firms typically externalize labor—draw on external labor markets—when they recruit workers.
Under normal conditions, internalization increases the employer’s organizational control over employees, whereas externalization enhances organizational flexibility. Externalization of labor is typically seen as a means to complement internalization and to circumvent some of the problems created by internal labor markets. In some Western countries, the external labor market is extremely dynamic, as in the United States where the proportion of new job-person matches over a five-year period has been estimated to be about 40 percent, with significant variations across age groups. General inter-country comparisons are not very revealing if they ignore differences in labor movement in terms of opportunity factors such as the size distribution of firms in a given industry and the degree of job growth over the business cycle
Recent decades have seen significant developments in labor markets in the international arena, as firms are trying to regain some of the competitiveness they have lost because of rising labor costs and the growing success of producers in newly industrializing nations. One strategy many firms use to contain labor costs is to introduce a variety of flexible working arrangements that are expected to improve the link between the level of output and the demand for labor. Some of these arrangements are based on using the external labor market as a source of employment flexibility. The most prominent of these arrangements include increased reliance on subcontracting and the increased use of temporary employment contracts. Both are considered forms of employment externalization. Externalization through the use of temporary workers has the effect of reducing the duration of employed labor in the firm, whereas externalization through subcontracting activities to independent workers is a means of increasing flexibility by reducing administrative control over labor.
Subcontracting involves the replacement of employment contracts in the firm with commercial contracts with external firms supplying specialized inputs. This approach is widely used in industries facing volatile market conditions, such as construction, where workers move from one contract to the next or are laid off until the firm obtains another order. They are also frequently used in industries that rely heavily on project work, as in the cultural sector (e.g., performing arts, film production, writing, and publishing). In these industries, many firms can meet fluctuating demand best by outsourcing activities to specialized organizations and individuals that can supply them at the time when they are needed, while retaining in-house those activities that focus on their core business.
Temporary employment refers to the use of workers hired for a fixed term. These include workers provided by temporary help service agencies, limited-duration hires, and call-ins. In many countries, temporary workers (often referred to also as contingent workers) have comprised one of the fastest growing labor force segments. It would be wrong to view contingent workers primarily as low skilled. Contingent workers include professionals such as engineers, teachers, nurses, and orchestra directors. Many of these temporary workers are highly paid, and there is some evidence that many of them view their temporary employment as voluntary rather than imposed by the state of the labor market. Temporary status may also lead to permanent employment, if the firm uses the arrangement as a recruitment device to observe the worker’s qualifications and commitment until a decision is made whether to offer long-term employment.
Research typically explains the use of subcontracted and temporary labor in terms of the advantages contingent employment arrangements produce for the employer in terms of flexible staffing, cost savings, obtaining expertise, and a variety of other benefits. One may distinguish between numerical and functional staffing flexibility. Numerical flexibility refers to the ability to adjust staffing levels to changes in market conditions more easily than what is possible with permanent staff who are protected by government regulations regarding hiring and firing and who expect employment stability. Functional flexibility contributes required skills to the firm that are costly to develop in-house, especially if they are used only sporadically or are difficult to monitor by the employer because control over the use of skills lies with the worker. Drawing workers from the external labor market also provides the firm with cost flexibility to the extent that it can economize on fringe benefits and social insurance payments. And the use of independent contractors allows the firm to provide a broad range of specialized products without incurring the risks from large investments in recruitment, skill training, and labor monitoring.
When are firms most likely to externalize labor? The use of temporary workers is certainly not a new phenomenon. Employers have long organized production around fixed-term (and part-time) positions in order to cope with fluctuating market demand, as in retail and the hospitality industry. What appears to be new is the extent to which firms rely on contingent workers to hold down labor costs. It would also be too simple to argue that firms draw (more) extensively on external labor markets only because high(er) levels of uncertainty in product markets require a strong(er) concern for containing labor costs. A focus on market uncertainty and labor costs is in many cases too narrow. While the employment of contingent workers may help to contain labor costs, organizational factors and job factors may reduce these cost savings.
An important variable to consider is the nature and extent of workflow interdependence. In those cases where activities and jobs are highly interdependent, extensive use of temporary or contract workers carries the risk of disruption and insufficient control over the flow of labor resources. Research suggests that firms are more likely to externalize labor if parts of the production process can be distributed and technologies are available that enable outsourcing and adjusting the volume of output. There are also organizational factors to be considered. If, for example, employers cannot introduce bureaucratic controls—for example, because of union rules or government regulation—to ensure a sufficient level of commitment on the part of short-duration hires, they are less likely to externalize employment. Within any organization, there are a range of “hidden costs” associated with monitoring, motivating, resolving conflicts, and coordinating permanent and nonpermanent workers that limit firms’ use of external labor markets.
The evidence shows that there is a clear trend toward increased labor market flexibility in many industrial countries. However, this trend builds on markedly different bases. Extensive reliance on external labor markets has existed in the United States for a long time. Employers in Europe seem to be catching up fast, although in varying degrees in different European countries. Also, the form and nature of labor externalization is different across countries. In Europe, one can observe a north/south divide, with part-time and temporary employment arrangements being more popular with employers in many southern European countries.
Variability in labor externalization is not determined by employment legislation alone. Firms in both high-regulated and low-regulated countries draw on external labor markets, and in many cases the increase in labor externalization in recent decades is similar. There is some debate concerning whether there is convergence or divergence across countries in firms’ reliance on external labor markets. Those who argue that divergence is taking place suggest that, despite globalization, firms continue to be embedded in regionally or nationally distinct societal and institutional arrangements. Others who observe international convergence argue that firms’ practices are increasingly disembodied of the national context, overriding more regionally or nationally specific institutions or cultural predispositions.
Some also suggest that convergence is a function of business activities becoming internationalized through exposure to customers, suppliers, or alliances with foreign firms. Even enterprises that do not participate in international markets are subject to competitive pressures and regulations. By imitating and learning from each other, firms adopt common organizational practices, including recruiting workers from the external labor market.
- Brewster, L. Mayne, and O. Tregaskis, “Flexible Working in Europe,” Journal of World Business (v.32/2, 1997);
- Florence Jaumotte and Irina Tytell, How Has the Globalization of Labor Affected the Labor Share in Advanced Countries? (International Monetary Fund, 2007);
- John Masters and Grant Miles, “Predicting the Use of External Labor Arrangements: A Test of the Transaction Costs Perspective,” Academy of Management Journal (v.45/2, April 2002);
- Jan Rutkowski, Labor Market Developments During Economic Transition (World Bank, Europe and Central Asia Region, Human Development Sector Unit, 2006);
- Vicky Smith, “New Forms of Work Organization,” Annual Review of Sociology (v.23, 1997).
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