The labour market includes all markets in which people sell their mental and physical services in employment from which they earn their living (Kersley 2006). It is a part of the economy in which various kinds of industrial and commercial services intermediated by people are brought, sold and priced. Employment, therefore, refers to participation in this labour market on its supply and/or demand side, the buying and selling of labour as a distinct factor among the various factors of production such as capital (Gintis 1987). The individuals selling their services in the labour market are referred to as workers or labourers and the pay that they receive in return for such contribution and effort is referred to as wages which can either be in the form of a weekly wage, a monthly salary, bonuses and other forms of remuneration (CIPD 2008).

Payment or reward is a core element of the employment relationship and is defined, in economics, as the portion of the national product that represents the aggregate paid for individuals contributing labour and services which is distinguished from the portion retained by management or reinvested in capital (CIPD 2008). Labour wage is a significant source of income for a major segment of the population, a primary contributor to their sustenance often referred to as a source of living. It also features prominently in the microeconomics of governments through its effect on the national policies such as taxation and supply and demand for goods and services with the resultant government revenues and resources allocated to a variety of alternative uses (IDS 2006).

There have been several theories and models that have attempted to explain the various phenomena surrounding the labour market among other markets. This paper delves into the Neoclassical theory of pay, its faults, limitations and criticisms and the alternative labour theories challenging it, as well as strategies and practices for pay determination at the level of the state and the firm.

Neo-classical theory of pay

Analysis of capitalism through the Neoclassical theory basically entails the examination of market relations of determinate actors, featuring technology and psychology, viewing the organization within the capitalist enterprise as the solution to the main challenge of finding techniques of production with the least cost, considering an array of the prices of various factors(Gintis 1987). This is in line with capitalism’s reduction of essential economic relations between freely acting, mutually benefiting firms and households engaging in independent exchanges. Neoclassical theories on labour economics basically consist of the theory of demand based on marginal productivity, the endeavour of employers to maximize profit and theory of supply based on maximization of utility by workers (Glen 1976).

This Neoclassical theory encompasses and is fundamentally guided by assumptions including the view that individuals through their rationalization of preferences among various outcomes maximize utility while firms endeavour to maximize their profits; and that people’s actions are based on their consideration of relevant information, all occurring in a circular flow in a closed market (Gintis 1987). Workers in this theory balance gains from the offer of the marginal unit of their contribution (their wage), with their loss of leisure, a disutility, while firms in their hiring of employees balance the resultant cost with the value output of the additional employee (Kessler 2007).

This theory makes the assumption that each worker has ordered preferences over the jobs in the labour market/economy with a capacity of performing at higher or lower productivity levels in each of them, treating labour just as a factor of production (a commodity) and blurring the distinction between labour, the entity that gets into the production process, the concrete, active process in the worker’s contribution expressed by labour power and its capacity for capitalist exploitation; and the labour power, the commodity with attributes including the capacity for the performance of some productive activity of varying types and intensities. This commodity is exchanged in the market, valued and tagged with a price (wage) (Gintis 1987).

This theory is generally useful in its simplification of the consideration of the labour market, and consequently payment, in view of the total capitalist enterprise and the many factors of production that are employed (Glen 1976). It has its strengths in traditional pay systems and payment that have been examined in consideration of the objectives of recruitment, retention and employee motivation with the assumption that equilibrium pay is attained through the interaction of market forces that are also useful in determining pay. This is of significant use in removing the complexities of attempts to understand social relations in the workplace and its requirement for a focus on psychology (IDS 2006).

Its perspective places values on the relationships between factors or objects and the persons seeking or obtaining them, between costs of production and the elements subject to the forces of supply and demand (Gintis 1987). In a capital market, each factor’s demand and supply is derived to those of the final output analogously to determine equilibrium in income and its distribution. This basic Neoclassical model of the labour market is based on assumptions which include perfect competition, maximization of profit, and homogeneity within the workforce, suggesting that wages should be equal. Its vision involves households or firms, described as economic agents, optimizing subject to some constraints or scarcity, with the tensions and decision problems being worked out in the market (Kessler 2007).

This theory is, however, faulted for being rigid and highly mechanistic, with strict assumptions, and its treatment of labour as a commodity, blurring the distinction between the active contribution of workers (labour) and labour power exchanged on the market for pay as a factor of production. Labour cannot be categorized under technological data as it depends on the worker’s biology, consciousness and skill, conditions of the labour market, solidarity with others, and the social organization within the process of work, as it is in essence a social relationship (Glen 1976). In this theory, the worker is valued as capital whose value rises with demand and supply and is looked upon as any other commodity or factor of production, thereby reducing all social relationships to exchange relations, a feature of the capitalist production process (Kessler 2007).

It is also faulted for its handling of the labour exchange with its basis on a crucial assumption that the exchange of labour for a wage (the labour exchange) can be treated as an exchange of commodities, a derivation from mathematical formulations of the general equilibrium theory (Gintis 1987). This is, however, incorrect as the capitalist firm’s hallmark is the reliance on authoritative allocation of activity rather than as a result of market forces. This is evident when internal movements within departments are not due to relative changes in prices as would be implied by the Neoclassical theory, but is done through the authority of management giving orders (Traxler 2003).

The tangible substance of labour entering the production process is distinct conceptually and must be analyzed in different terms. Labour is not exchanged for the wage according to the principles of the market, as the capitalist and worker power relations are the result of the economic organization which cannot be assumed as given before an economic analysis is conducted (Traxler 2003).

The limitations of the Neoclassical theory of pay include its lack of capacity in explaining the existence of pay differentials as wage scales generally deviate from its analysis of demand and supply (Glen 1976). Wage scales and their manipulation are often instruments used in an enterprise’s labour exchange to ensure integrity, an internal labour market that develops along with the labour market as traditionally perceived but having a fundamental qualitative difference in the exchange, and is also an instrument through which the state controls and manages its microeconomic environment (CIPD 2008).

Other limitations include its attempts to attribute discrepancies to market failures or events occurring outside the closed market system and interfering with its operation, as well as, its assertion claiming efficiency of capitalist production internal to the organization (Glen 1976). If profit is not deemed to entail efficiency, the wage may therefore be representative of the marginal contribution of the worker, without being representative of their productivity. Evidence bearing on the adequacy of its assertion regarding marginal productivity such as indices of skill and abilities, behaviour records, and supervisor ratings can hardly be precisely measured and are indirect. Therefore, individuals who have productivities differing widely will often be in the same positions covered by the same wage (Kersley 2006).

Its major criticism is significantly premised on the pay equalization of demand and supply, the assumption that forces similar to those of other markets are also in play in the labour market and that therefore rates of pay should swing similar to these forces (Glen 1976). This is, however, a false premise as there exists differentials in pay within the labour market not related to demand and supply, differentials that result from variations in quality of human capital; the presence of barriers to movements within different sectors due to high costs (including time) of training thereby resulting in non-competing groups within the labour market; the creation of partially closed markets through balkanization and unionization; and a myriad of social factors that often influence pay (IDS 2006). Alternative labour theories have thus been developed in attempts to explain the existence of pay differentials within the labour market and cover for the shortcomings of the Neoclassical theory of pay.

Alternative labour market theories

Human capital theory

Human capital theory relaxes the assumption of homogeneity in the basic Neoclassical model by addressing the heterogeneous nature of the labour market. It seeks to explain that wage differentials are a consequence of differences in human capital stocks, the stock of knowledge, skills, education, training and aptitudes that individuals or groups possess (Forth 2000). In the basic Neoclassical model, wages are paid basing on the marginal product of labour while the Human Capital theory links wage differentials to productivity differentials with the former a by-product of the latter (Gintis 1987).

Disparities in Human capital transfers into variable productivity and therefore different wages earned. For instance, workers with more education or unique learned skills, on average, earn more wages and this is explained by the human capital analysis as resulting from the increase in productivity among those with enhanced training. It follows that individuals who invest time (opportunity cost that can be evaluated in monetary terms) and money to gain more skill enhance both the human capital stock and ultimately their productivity (Forth 2000). This consequently results in the wage differentials between them and those within the workforce who made no such investment.

Non competing groups

These consist of several defined classes based mainly on gaps in skills or gaps in locations creating barriers to free movement in the labour market. There is therefore not a single labour market but a number of separate labour markets divided mainly by gaps in skills. Workers in one of these defined markets do not compete with workers in the other markets due to the presence of a skills gap, and the labour market is therefore not as homogenous as assumed by the Neoclassical theory (Forth 2000).

Sportspeople like footballers, for instance, with their special talent, just as other unique jobs that require unique talents as art and music form non competing groups with their own closed labour markets (not shared with everyone else), that despite having enhanced pay levels that would under the Neoclassical theory be a cause for a shift due to forces of demand and supply, however feature little movement between them and the other labour markets (Kersley 2006). The footballer is therefore not in any competition with a doctor as they are members of non competing groups that have little chance of transfers between their markets, hindered by skills gaps and rare abilities.


Balkanization results when workers organize themselves into unions seeking the establishment of sovereignty over job territory, a form of private government of a section of the labour market (Kersley 2006). In this territory, the demands of members of these unions are met before petitions of aliens are considered. This effectively brings about change in market considerations from individual preferences and involvement to a more plural and partially closed society (Traxler 2003).

Balkanization creates boundaries within the labour market, which are specific and challenging to cross, with the association or union defining points of competition, the groups that may compete, and the grounds for such competition (CIPD 2008). Examples of balkanized groups include doctors and accountants who have strong and wide-reaching associations which take up the mandate of overseeing and controlling what happens in their specific labour markets under the boundaries created. The labour market unlike that described in the Neoclassical theory is not homogenous under such balkanization with the characteristic barriers to free movement and individual preferences (Gintis 1987).

Social factors

Differentials in wage could also result from direct influence of a number of social factors which may include gender, geographic locations, demographics, race, among other factors. Of significance among the social factors is the gender pay factor which results in the presence of a pay gap between the different genders. The weekly earnings of women working full-time rose 4.2% in 2006 while those of men rose by 3.5%. This was despite the fact that women’s earnings fell significantly below those of their male counterparts (CIPD 2008).

The gender pay gap measured by the Annual Survey of Hours and Earnings (ASHE), published by the Office for National Statistics (ONS) through median hourly earnings excluding overtime (government’s preference) though narrowing from 12.1% in 2009 (ASHE 2009) to 10.2% in 2010 (ASHE 2010), a result not from a rise in women’s wages but from a fall in the growth of men’s pay at 0.3% in 2010 relative to 2.6% for women, still retains the variation. The private sector is shown to have a wider gender pay gap at 19.8% nearly double that in the public sector at 10% (ASHE 2010). Alternatively, based on average hourly earnings (putting more weight at the pay extremes at the top and at the bottom) ASHE found that the gender pay gap was down almost a percentage point to 15.5% in 2010 from 16.4% in 2009 (ASHE 2010). The Equal Opportunities Commission (EOC) argues for these extreme values are vital to the explanation of the pay gap as the highest earning jobs are still a preserve and are heavily skewed towards the male workers, and vice versa (Forth 2000).

This gender pay gap could structurally be as a result of differences between men and women in the jobs they engage, occupational segregation within the workforce and the general undervaluation of the jobs women dominate; the length experience of work as well as that of part-time employment; their qualifications and skills; issues regarding travel to work among other unobserved factors including discrimination at work (Kersley 2006).

Role of the state

The state takes up an oversight role in pay determination as it seeks to manage its economic environment. The labour market affects the performance of the economic system substantially with its effect on opportunities for the workers and its contribution to the national product, as well as, focusing on its expenditure limits and inflation targets (Traxler 2003). There are several mechanisms through which the state engages in pay determination and influences pay levels. These include direct approaches such as policy formulation to define pay levels, the use of collective bargaining mechanisms and indirect mechanisms such as the emulation of private sector strategies and the development of sector schemes covering labour markets.

Direct mechanisms include legislation such as the equal pay act seeking consistency, equality and fairness in pay, and ensuring that all receive the same pay for the same amount of labour and across gender. There are also several legislations such as those covering remuneration recommendations for school teachers covered by the 1991 Act that have to be approved by parliament (IDS 2006). These mechanisms also entail the involvement of the pay labour board in local determination of grading structures and rates, pay review bodies (PRB systems) that determine pay for public servants acting midway between collective bargaining and government imposition, with features common with the statutory wage boards in which various parties are engaged in decision of outcomes (Forth 2000).

Collective bargaining entails either negotiations on industry-wide agreements on minimum rates that would apply to an organization or bargaining on the enterprise level over pay levels among other terms. This often involves the employment of unions and associations to engage in the negotiations and often contribute to the setup of minimum wage levels (Forth 2000).

The indirect mechanisms entail the use of job evaluation and analytical schemes. These seek to enhance equity in pay and systems of grading through the determination of the relative importance of jobs, thus informing decisions about banding and remuneration. It is done through systematic processes that bring a degree of objectivity to the making of such decisions (CIPD 2008). These schemes include proprietary schemes used by multiple employers and supplied by consultancies or some overarching schemes that cover an entire part of the public sector meeting the needs of their particular sectors, home grown schemes of individual organizations and hybrid schemes that are in between (Kersley 2006).

An example of the overarching schemes is the National Health Sector scheme (NHS) which can also be used, for a fee, by private organizations, which covering a wide range of jobs that are contained within the health sector from the obvious medical to management and administration and jobs in between with pay system strategies (Traxler 2003).

Firm level

Within the firm, pay determination and strategies are influenced by external influences such as the involvement of the state in setting minimum wage, and comparator data from industry surveys of competitive rates, as well as, internal considerations such as performance and productivity of individual employees. These influence company profitability and therefore available resources (its ability to pay), and the focus, therefore, is on effective organizational structures necessary in a capitalist system to enhance efficiency and productivity (Kersley 2006).

A grading or pay structure identifies the expectations from the effort-bargain for different levels and provides a basis for the differentials (Kersley 2006). The hierarchical structure in capitalist enterprises with a matching pay structure is indicative of pay differentials within the organization and industry, reinforcing the structure and desired goals within the organization as it features discretionary and variable pay systems that can flexibly adjusted to suit patterns (Forth 2000).

The worth of each job or employee is also subject to external influences such as relative market value and the social value of particular skills and duties which are variable with time (IDS 2006). The pay system within the organization has continually changed in composition towards performance-orientation intended to enhance productivity and profits which has led to the development and employment of performance-related pay based on certain performance criteria including individual performance or profitability within the organization, in addition to, basic pay (Kessler 2007)


The Neoclassical theory which though successful in explaining various phenomena surrounding the labour exchange, and simplifying the consideration of the labour exchange among the several factors of production in the capitalist enterprise, has shortcomings and limitations in its rigidity and its handling of labour as a commodity, a factor of production, as well as focusing on market forces of supply and demand thereby deeming labour to also be affected.

However, there clearly exist variations to its assumptions that result in pay differentials which are then explained by alternative theories including the Human Capital theory which explains variations in pay through differences in worker’s skills sets and abilities, balkanization and non competing groups which shatter the homogeneity assumption, and the presence of a variety of social factors. The state and the firm have also through pay strategies and practices reinforced such differentials through various schemes, and means available to them and that are desirous for their particular goals which include economic management for the state and profitability for the firm.


Annual Survey of Hours and Earnings (ASHE), 2009. Office for National Statistics. Viewed from on 12th May 2012.

Annual Survey of Hours and Earnings (ASHE), 2010. Office for National Statistics. Viewed from on 12th May 2012.

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