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Analysis Of The Role Of Labour Market Imperfections In Generating Unemployment

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In contemporary times, globalization has affected the international labour market in such a way that advance countries now have the means to seek for cheap labours. The free trade doctrine advocated by the neo liberalists has opened the economy of countries; even the communist’s states are now welcoming the free entry and exit of labour. Neo liberals have fostered the movement to freer trade and deregulation of labour markets, arguing that overcoming the constant of limited markets is the means to increase growth, remedy trade imbalances, and lower unemployment.

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The state needs to be forced to comply with the laws of the market” Samuelson (2004). To a great extend the neo-liberalist doctrine has gone a long way in influencing how political decisions are made regarding public policies on trade and workers-labour relationship. The minimum wage paid to workers in other country most times is a basis for labour union leaders in poorly remunerated economy to rise up protest for wage increment.

The workers knowing the implication of low pay compared to their counterpart, how this would reduce their economic purchasing power. This factor spurs workers and makes them agitate for pay raise.

 Failure in the international labour market is linked by some scholars to the similarity of public policies adopted by government of different states. Public policies regarding labour market regulations have reduced the forces of new jobs generation.  According to Solow (1997, pg 3) cited in Gahan and Harcourt 1999, pg 11) “result of excessive and anti-competitive product-market regulation, restrictive macroeconomic policy that is linked to monetary policies, and inadequate discipline from capital market caused weakness in job creation”.  This weakness of job creation has resulted in imperfection in the labour market.


The structure a country has on ground that supports its labour market goes on to determine how it can withstand the reaction of imperfections in the labour market on the generation of unemployment. As all countries posse their own labour market institutions, these are characterised by specific structure that  has to do with regulations on hiring and firing decisions, how industrial disputes resolutions are embarked on,  and workers welfare provision and protection to the unemployed. The presence of powerful trade unions and collective bargaining institutions goes on to affect the wage determination and the level of gainful employment in a country. According to Nickell (1997) “The differences in these institutions in the labour market, from country to country, can be important determinants of a range of labour market outcomes to give explanations to differences in unemployment-employment rates, wage levels and earnings inequality”.

A labour market that is characterised by pure unadulterated structures tends to consolidate the forces of job creation, thereby reducing the level of unemployment. The productive efficiency that is derived from structures available in the labour market goes a long way in ensuring job security and adequate wage for workers.

Imperfections in labour market have created wage inequalities which have lead to poor labour motivation which affects their productivity at the long run. According to Leslie (1996), policies adopted by some state government to reform labour market has gone to reduce their bargaining power. This was mostly reflected in United Kingdom and U.S. economy in the 1980s. While advancement in technology has encouraged the gap in wage inequalities by putting workers with higher skills at an advantage over others, this is not the sole reason for wage inequalities that is a feature in an imperfect labour market. Some workers of equal class and homogenous characteristics still face wage inequality which has increase the effect of international competition leading to changes in labour market institutions (ibid). Thus, the argument here is that imperfect market characterised by wage inequality that has led to the weakness in job creation is a spill over of wrong reform policies by states for labour market.

Furthermore, another perspective in viewing the wage inequalities brought by imperfections of labour market is through the insiders – outsiders’ actions in causing rigidity in the market. The insiders, who constitute the currently employed workers, in their quest to keep wages rigidly fixed in the face of negative labour demand shocks goes on to preventing the unemployed from being hired. With the status of the outsiders, i.e. the unemployed workers, they are left with less power to bid for employment. In this regards, according to Lindbeck & Snower (1988), “the insider-outsider models propose a view where labour market institutions may isolate currently employed workers from underbidding by the unemployed”. The implication of this is that the insider power is associated with the cause of persistent unemployment and wage processes (ibid).

Another dimension to imperfection in labour market which leads to increase in unemployment has to do with discriminatory stance of employers of labour to certain class in the society. Discriminatory behaviour ensures when employers of labour in a bit to create satisfaction to customers tends to be bias in workers recruitment. These in most times is derived from statistical discrimination, based on imperfect workers information on their productivity level, including other varying conditions. There is still to some extend of employment discrimination that is attributed to racial and stereotyping affiliations. Even though, these in most case are not covertly done, it would be wrong to assume that minorities are not discriminated at during employment process. According to Neal & Johnson report, as cited in Holzer (1999), there is a significant racial difference in annual earnings, which reflect employment rates over the year as well as wages. This difference is arrived at even after a controlled test score to determine workers productivity levels.

Furthermore, labour market imperfections leading to unskilled workers is encouraged by the lack of adequate trainings for workers and the inability for workers to pay for their self’s development. In period of boom in a country’s economy, where there are unskilled labours, their presence still causes classical unemployment. This mismatch between unskilled labour and the available job is an imbalance between the characteristics of employers and the jobs on the demand side of labour market, and those of workers on the supply side. According to Holzer (1999) “even in equilibrium this market mismatch would result in low market wages that would lead to labour market withdrawals and high rates of ‘nonemployment’, instead of unemployment, for these unskilled labours”.

However, in recent times, the financial meltdown is really taking its impacts in advance countries, where thousands of workers are being retrenched on daily basis, in the automobile industry, financial institutions inter-alia. The labour market which is the supplier of labour to the active sectors of the economy is affected by the financial crunch and meltdown in the current global crisis. Both the advance countries and developing ones are directly affected in this regards. According to Manning (1995) “In particular, in Europe a negative shock of unemployment seems to be followed, in the short run, by a reduction in the incidence of long-term unemployment as marginal segments of the labour force reduce search intensity and/or withdraw from the labour market. At the long-run unemployment persist and more stable part of the labour force is hit, bringing an incidence that would generate increase in the progression of unemployment”.  The longer the persistent of imperfections in the labour market the increase the level of unemployment. In the US unemployment index, during the 1990s, there was a constant stability in the long-term joblessness figure overtime, where long-term unemployment was little affected by the overall rate of unemployment. During this same the persistent high rise in unemployment in European countries such as Italy among others, was blamed on imperfections and rigidities emanating form the labour market (ibid). According to Soskice (1990), studies have shown that corporatist countries were able to adjust to more effectively such shocks caused by imperfections in labour market, just as aforementioned with the US illustration in the previous paragraph.

Thus, the differences in unemployment rates in countries as a result of imperfections in labour market lie in the exit rate from the unemployment pool that is built around the labour market structures of a country. In other words, any explanation for the rise of unemployment in a country should be explained alongside the decline in the average outflow rate which ahs to do with the hiring obstacles.


The data for unemployment in less developed countries and developing countries in Asia, Latin America and Africa continents are alarming. In line with the gap in wage inequality associated with labour market imperfections is fuelled by the position a country finds itself in the international trade market. For advance countries they enjoy vintage position compared to the less developed states.

To analyse the imperfections that labour market brings would not be complete without taking a look at the economies of countries how imbalances in trade affect the workers and indirectly contribute to the unemployment index of a country. The evidence of inability of less developed countries to absorb the shock that imperfections from labour market bring has resulted in the high rate of unemployment they record.

An advancement of the Ricardian trade model sees countries producing semi finished goods and exporting it to another country to continue the chain of production until the goods becomes finished goods for consumption. Example of this is a situation where Mexico import raw steel from Japan, and stamp and pressed them to be exported to United States where the steels are used for manufacturing tractors and other farm implements. According to Hummels et al (1999), the vertical specialization involved in the trade of semi-finished goods among nations has the key feature of which is that imported inputs are used to produce a country’s export goods. “Our concept emphasizes the twin notions that the production sequence of a good involves at least two countries, and that during this sequence, the good-in-process crosses at least two international borders. This latter notion highlights the sequential production, the multiple-border crossing, and the back-and-forth aspect of an increasing amount of international trade” (ibid). This notion further goes to amplify the interconnectivity effect of wage differentiation between workers in the same industry in the international arena. The workers in developing countries that mainly deal in the exploration of raw materials as their means for foreign exchange usually are not in anyway comparable with workers in advance countries with higher pay structure for their workers. Even the fact that workers in developing or under developed countries perform the same function in the same industry and specialized function, this difference is still obvious. One significant fact leading to this wage differences is because of the price attached to the produced goods from the developed countries and those from developing or underdeveloped countries. It is a known fact that raw materials in the international trade are valued far less than the transformed finished products from advance countries.

As aforementioned, small economy, countries primary goods based on exploration of natural resources are poorly priced compared to the finished product produced by developed countries. The fear of small countries is on how their international trade would lead to the stiffing of their economy, through lost of labour as result of brain drain, and a non-comparative basis for ensuring thriving of their economy, when terms of trade is not much favourable to them. According to Davis (1996), “Small countries have long feared economic dominance by their larger neighbours. One element of this is concern that increased economic integration would lead important segments of national industry to abandon the smaller for the larger market. Insofar as these fears are based on market size, they find no foundation in traditional theories of trade due to comparative advantage. While such trade may restructure national industry, the direction of the change will depend not at all on relative market size”. Market size of a country’s economy goes a long in determining the industrial strength of companies operating in such economy. In the case of small economy, their involvement in international trade has not favoured the development of their industry, in terms of vibrant development resulting from maximization of the best output for labour. The differences in wage payment to labour between a developed economy and those for less developed countries sometimes affect the motivating force that spurs workers to put in their best in ensuring high productive results for the organization they work for. The operational cost for organization operating in a small and underdeveloped economy leaves little room for them to engage in high wage payment compared to what is obtainable in advanced countries. Thus, based on the international trade concept of Ricardian theory the comparative advantage derived from product differentiation is favourable to developed and advanced economy. This is mostly, adduced to the pricing system in the international trade arena, as aforementioned where primary resource goods are under priced compared to prices for goods such as machineries, electronics, automobiles. This scenario has made workers in less developed economies to be worse off, thus leaving little room for development to their countries economies. This imperfection in international labour market has lead to the high rate of unemployment in less developed countries compared to some advance economies that could withstand the shocks of the imperfections in their labour market.


Davis, Donald R. (1996), “The Home Market, Trade, and Industrial Structure” http://www.newyorkfed.org/research/staff_reports/sr35.pdf (27/01/07)

Gahan, Peter & Harcourt, Tim (1999), “Australian Labour market Institutions, ‘Deregulation’ and the Open Economy” http://www.cid.harvard.edu/cidtrade/Papers/LabourInstit.pdf. (10-12-08)

Holzer, Harry J. (1999), “Mismatch In The Low-Wage Labor Market” Chapter 6 in Job Hiring Perspective. http://www.urban.org/UploadedPDF/lowwage_labor_FR.pdf#page=139. (10-12-08).

Hummels, David et al (1999) “The Nature and Growth of Vertical Specialization in World Trade” http://www.newyorkfed.org/research/staff_reports/sr72.pdf (27/01/07)

Leslie, D. and Pu. Y. (1996) ‘What Caused Rising Earnings Inequality in Britain? Evidence from Time Series, 1970-1993,’ British Journal of Industrial Relations, 34(1), March: 111-31.

Leslie, Papke (1992) “What Do We Know about Enterprise Zones?” National Bureau of Economic Research Working Paper.

Lindbeck, A. and Snower, D. (1988) The Insiders-Outsiders Theory of Employment and Unemployment, IT Press, Cambridge Mass.

Manning, A. and Machin, S. (1999) “The Causes and Consequences of Long-Term Unemployment in Europe”, in O.Ashenfelter and D.Card (eds.), Handbook of Labour Economics, Vol.3, North Holland.

Nickell, S.J. (1997) ‘Unemployment and Labour Market Rigidities: Europe versus North America,’ Journal of Economic Perspectives, 11(3), Summer: 55-74

Samuelson Paul A. (2004), Where Ricardo and Mill Rebut and Confirm Arguments of Mainstream Economists Supporting Globalization Journal of Economic Perspectives—Volume 18, Number 3—Summer—P. 135. http://www.uni-konstanz.de/FuF/wiwi/vwl/HPGrieben/download/Samuelson_mainstream_arguments_JEP_2004.pdf (12/06/06).

Soskice, D.W. (1990) ‘Wage Determination: the Changing Role of Institutions in Advanced Industrialized Countries,’ Oxford Review of Economic Policy, Winter, pp. 36-61.

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Analysis Of The Role Of Labour Market Imperfections In Generating Unemployment. (2016, Jun 16). Retrieved from https://graduateway.com/analysis-of-the-role-of-labour-market-imperfections-in-generating-unemployment/

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