Role of Labour Market Imperfections in Generating Unemployment Essay

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Similar to product markets, labour markets tend to be characterised by imperfections. The imperfections stem from factors such as monopsony, trade unions, wage discrimination, labour immobility, government interventions, as well as incomplete information on the part of workers (Manning, 2010; Abbritti, Boitami and Damiani, 2012). Indeed, labour markets are persistently imperfectly competitive (Dwivedi, 2010). Imperfections in the labour market often play a significant role in generating unemployment (Baker et al., 2004; Jha and Golder, 2008). They do so by hindering employment creation, determining wages, and creating wage inequalities (Boeri and Ours, 2013). With reference to Europe, this paper analyses the link between labour market imperfections and unemployment. First, a description of labour market imperfections is provided. Then, with empirical evidence from Europe, the role of labour market imperfections in generating unemployment is discussed. 

Imperfections generally refer to failures. Labour market imperfections, therefore, denote failures in the labour market (Abbritti, Boitami and Damiani, 2012). The failures often emanate from efforts aimed at promoting equity and fairness in the labour market (Manning, 2010). For instance, the government may introduce legislation to curb minimum wage at a certain limit. The government may also introduce insurance benefits to improve the wellbeing of the unemployed. Additionally, workers may unionise to advocate for better pay and improved working conditions. While these efforts are intended to positively affect the labour market, they may often generate unemployment and other undesirable outcomes (Dwivedi, 2010). They may result in imperfections that may be detrimental to investment, economic activity, as well as efficient resource allocation, consequently obstructing employment growth.    

Major labour market factors that generate unemployment relate to labour market institutions and regulations. Labour market institutions and regulations generally denote interventions by the government (Boeri and Ours, 2013). They include elements such as employment legislation, labour market policies, unemployment insurance, unions, and payroll taxes. These elements create unemployment by hindering the free working of labour markets (Baker et al., 2004). They impose rigidities on the labour market and decelerate the growth of employment. For instance, employment protection policies and unionisation can reduce organisations’ demand for labour and detriment workplace productivity. Equally, government-imposed labour market policies as well as labour taxes can increase labour costs and decrease hiring.

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Also, huge unemployment benefits can increase employees’ reservation wages and reduce the desire to search for work. Whereas these institutional and regulatory elements are important, they can negatively affect employment creation if they are excessively protective and weakly designed. 

Further, labour market regulations may hinder employment growth by disrupting equilibrium between wages and their marginal product as well as hampering the ability of labour markets to adjust to various shifts in the economic environment (Jha and Golder, 2008). This may result in negative outcomes such as resource misallocation (Boeri and Ours, 2013). For instance, regulations that mandate increased minimum wage may condense the wage structure, leading to the elimination of less skilled employees from the labour market, thereby increasing unemployment. Additionally, labour market institutions may prevent employers from adjusting resource quantities in accordance to the prevailing economic conditions. During economic recession, for example, firms may not readily slash wages due to the prevailing market regulations. Moreover, collective bargaining systems and other regulations that support the redistribution of economic rents from capital to labour may increase production costs and hinder investment, consequently reducing employment creation opportunities (Jha and Golder, 2008). In essence, labour market institutions and regulations tend to disrupt equilibrium in the labour market. They distort the market since resources are often not allocated at market clearing prices as generally dictated by supply and demand principles.

Another negative impact of labour market institutions is that they make it harder for outsiders to enter the labour market (Jha and Golder, 2008). In other words, labour market regulations are mainly geared towards protecting the interests of those who are already employed, undesirably making it more difficult for the unemployed to get work. For instance, an increase in minimum wage and labour taxes due to government intervention may cause firms to reduce hiring as more hiring would increase operating costs. This would harm the labour market as the unemployed would remain in unemployment much longer. This outcome shows that the same labour market institutions and regulations intended to promote fairness and equity can somewhat perpetuate inequity. The unemployed would continue prospering while the unemployed would continue being worse off. The negative impacts of economic inequality.....

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Abbritti, M., Boitami, A. and Damiani, M. (2012): Labour market imperfections, “divine and     coincidence” and volatility of employment and inflation, Review of Economics and     Institutions, vol. 3, no. 1, pp. 1-37. 

Baker, D., Glyn, A., Howell, D. and Schmitt, J. (2004): Unemployment and labour market     institutions: the failure of the empirical case for deregulation, International Labour     Organisation, Working Paper No. 43.  

Boeri, T. and Ours, J. (2013): The economics of imperfect labour markets, Princeton:     Princeton University Press.

Dwivedi, D. (2010): Macroeconomics: theory and policy, 3rd ed., New York: McGraw-Hill. 

Jha, P. and Golder, S. (2008): Labour market regulation and economic performance: a     critical review of arguments and some plausible lessons for India, Economic and Labour Market Papers, International Labour Organisation. [online] Available at:     <>     [Accessed 28 November 2016].

Manning, A. (2010): Imperfect competition in the labour market, CEP Discussion Paper No     981. [online] Available at: <>     [Accessed 28 November 2016].    

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