Internal Labor Market Essay

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An internal labor market (ILM) is an administrative unit within an organization in which the hiring, promotion, and wages of workers are governed by a set of rules and procedures, resulting in a job hierarchy, or job ladder. Three factors lead to an ILM: firm-specific skills required for the ILM jobs; on-the-job training necessary to gain the firm-specific skills; and workplace customs that form to support the ILM. The port of entry into an ILM is typically at the bottom of the job ladder in a relatively low-skilled position, such as management trainee. It is what connects the internal labor market to the external labor market (ELM). The rest of the jobs within the ILM are filled by the promotion or transfer of workers who have already gained entry. When someone at the top of the job ladder leaves, workers in the unit move up a “rung,” which creates a vacancy at the bottom. Competition for these jobs is limited to workers already employed within the firm. This restriction of competition for the upper-level jobs to those already employed in the firm, who might not be the most skilled, is the primary cost of an ILM.
Port-of-entry jobs involve intense competition among applicants because it is an entry to promotions, higher earnings, and job security. The administrative unit also faces competition from other employers for workers at this entry level. For the unit, the decision of whom to hire for these jobs is crucial because the worker will ideally be with the firm for a long time, and the firm will invest in the worker in the form of often-expensive firm-specific training. Firms thus spend much time and money in the selection of workers for these port positions, much more so than for positions without a job ladder in which little or no firm-specific skills and training are required, such as clerical or custodial positions.
Wages for the port positions, as for those jobs without job ladders in which the skills are transferable across employers, are determined by competitive pressures in the ELM. However, since jobs in the ILM are not standardized, wages are more wide-ranging. The upper wage limit is the marginal revenue product (MRP) of the worker, or the value of the worker to the firm in terms of revenue generated. The firm will not pay a wage higher than the worker’s MRP—that would mean the extra cost of employing the worker (the wage) would be higher than the extra benefit of the worker to the firm. The lowest wage the firm would have to pay to retain the worker is what the worker would earn in the ELM, which would be much less than what the worker could earn in the current firm because the worker’s firm-specific skills would not be as valuable to another firm. If a worker in an ILM were to quit or be fired, he or she would lose the position on the job ladder and have to begin again at a (lower) port of entry at another firm.
The potential earnings loss from quitting an ILM creates lower labor turnover within the unit. This employee attachment to the firm and resulting lower turnover costs is an advantage of ILMs to the firm. Further, ILMs give employers an opportunity to observe productive characteristics of employees, allowing employers to make more informed decisions about whom to retain, train, and promote.

1. G. Baker and B. Holmstron, “Internal Labor Markets: Too Many Theories, Too Few Facts,” American Economic Review (v.85/2, 1995);
2. P. B. Doeringer and M. J. Piore, Internal Labor Markets and Manpower Analysis(Heath Lexington Books, 1971);
3. David Fairris, “Internal Labor Markets and Worker Quits,” Industrial Relations (v.43/3, 2004);
4. Ming-Jen Lin, “Opening the Black Box: The Internal Labor Markets of Company X,” Human Resources Abstracts (v.42/1, 2007);
5. Craig MacMillan, Internal Labour Markets: An Institutional Perspective on Recent Research in Personnel Economics (Department of Economics, Macquarie University, 2007);
6. I. Ohashi and T. Tachibanaki, eds., Internal Labour Markets, Incentives, and Employment (St. Martin’s Press, 1998).

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