INTERNAL AND EXTERNAL LABOR MARKETS:

A PERSONNEL ECONOMICS APPROACH

by Edward P. Lazear and Paul Oyer

Labour Economics, 11, October 2004, 527-554.

ABSTRACT

Internal labor markets are those where workers are hired into entry level jobs and higher levels are filled from within. Wages are determined internally and may be quite free of market pressure. External labor markets imply that workers move somewhat fluidly between firms and wages are determined by some aggregate process where firms do not have significant discretion over wage setting. There are a number of theories that lead to internal labor markets. Using data from Sweden from the late 1980s, it is found that although there is significant evidence of internal promotion being important, a significant external market exists that affects both wage setting and hiring patterns. Positions are filled by hiring outsiders at all levels of the typical firm. Even in Sweden, where many believe that job mobility is limited by institutional factors, external forces limit firmsí ability to set wages. The external forces are likely to reflect both centralized wage bargaining and market factors that take the form of substitute workers available outside the firm.