Equilibration in the Labor Market

Abstract

Do workers receive the wage a competitive labor market would award their capabilities, or do disequilibrium and structural factors in the labor market result in workers of comparable productive ability receiving sharply different wages over protracted periods of time? The extent to which competitive forces dominate the wage determination process has been and is a central and controversial issue in labor economics. The competitive theory of wage determination is the focal point of debate. A compact statement of the competitive theory is that, given the overall level of real wages, a worker's wage is determined by his productive capabilities-that is, by his innate ability and investments in human capital. While most economists have viewed the competitive theory as the standard model of the wage determination process, it has not gone unchallenged. The institutionalist thrust in labor economics during the early postwar period and the more recent internal and dual labor market theories are examples of such challenges.l Attempting to solidify support for their respective positions, both sides in the debate make extensive use of the cross-sectional wage regression as a major source of empirical evidence. Supporters of the competitive theory emphasize the standard finding that human capital variables such as education and experience, which are taken as proxies for productive ability, are important in explaining wage or earnings variation.2 Challengers, on the other hand, stress the antithetical finding that even after controlling for measured differences in productive ability the residual variation in wages is large and at least partially accounted for by market structure variables such as union membership and occupational and industrial status.3