The intense search for competitive advantage has resulted in new forms of work production (e.g. just-in-time production systems and industrial networks). There is a continuing debate about the nature and implications of these practices. We shall draw on both new institutionalist models of contractual relations and broader institutionalist approaches to analyse employment relations.

Three related characteristics that make labour distinctive from other factors of production, and make efficient labour use a difficult issue for employers:

• productivity of labour depends greatly on the motivation of the workers – workers will attempt to minimise work and effort, unless motivated to do otherwise;
• skills of workers cannot be separated from the owners of those skills; they bear significant risks by undertaking highly specific training, and so may underinvest;
• workers have discretion (i.e., freedom and will) over how their work is done; this generates inevitable struggle and conflicts between the managers and the workers.

Thus, labour is an elastic phenomenon, heavily dependent on the organisational structures, incentives and mutual understandings. In addition, the employment relationship is asymmetrical – employees’ obligations are vague and uncertain, and largely under the whim and authority of the employers. In contrast, employers have reasonably well-defined obligations including wages and working conditions.

Much economic analysis of the employment relation is a variant of the principal-agent problem. Employers (the principals) employ workers (the agents) to use their capital to make products that yield revenue. Workers can use their discretion about how they undertake their work to enhance their own self-interest rather than that of their employers.

Employers have to devise incentive payments systems that can minimise agency costs and moral hazards. The workers get disutility from work, their interests conflict with those of the employers. The workers have substantial discretion, and have hidden information about how hard they are working. Employers can measure workers’ output, but not the effort put in.

Employers can reward workers on piece-rate basis, but if external risks are substantial, the payment system will be resented and resisted (e.g., nurses and doctors would resist a payment system that rewards by the number of patients that live after an operation). A better system may be a fixed wage. However, the workers may then have no incentive to increase their effort, and would shirk. Efficient incentive contracts (such as sales assistant’s contracts) trade-off risk sharing and incentives.

It is appropriate to pay nurses on a fixed payment system, because it is hard to judge and measure their output (live or happy patients), to see and evaluate their efforts, and to assess whether recovery or illness is their responsibility or the doctors’ efforts. The situation is different for sales assistants, where effort and output are readily identifiable so that a piece-rate payment system is more suitable.

New institutionalist models of the principal-agent see a firm as characterised by a large number of internal contracts. The model has a close affinity with the transactions costs theories of the firm, since it sees the firm’s internal working relations as transactions. In the model of principal-agent, the contracts are both explicit and fairly complete. Although they assume asymmetric information, the contracts state what will occur in a wide range of expected states of the world.

Economic sociologists and old institutionalists suggest that employment contracts leave a good deal implicit, expecting much to be resolved through custom, practice and day-to-day goodwill. The employment relationship is therefore generally a good example of a relational contract. Such contracts:

• emerge when there is scope for mutual benefit from mutual commitment;
• allow for opportunistic behaviour, and work best where parties can trust each other to resist such opportunism.

Employers can respond to the need to trust workers in two ways:

• low trust approach: reduces workers’ discretion, controls the production system, and develops monitoring systems to check for shirking. However, this generates conflicts and instrumental thinking and behaviour that may reduce productivity;
• high trust approach: re-aligns workers’ interests with the firm, implements a liberal supervisory system, job security and high wages, and hopes to minimise opportunistic behaviour. However, this is costly and may be unsustainable.

Old institutional economists argue that firms pay wages above the minimum necessary in a given market, and are reluctant to cut wages in recessions. A class of economic models explain the reasons for these phenomena.

The efficiency wage hypothesis proposes that there is a positive relationship between wages and worker productivity. Five reasons are suggested for the link between high wages and high productivity:

• high wages reduce shirking by workers because of the higher cost of job loss;
• worker turnover is lowered as a result of raising wages, so reducing recruitment costs;
• high wages attract a better quality of job applicants;
• the workforce morale is improved as a consequence of higher wages;
• physical well-being is improved because of better paid workers.

The worker discipline model assumes that the employment contract is open-ended. Employers need to exercise some authority over the employees. This could involve close supervision and the dismissal of employees found to be shirking. However, dismissal is only an effective strategy if it is costly to the employee. The higher the cost of dismissal to the employee, the more effective is the threat and less need for close supervision.

A model with competing incentives: The worker discipline model assumes a trade-off between wage levels and intensity of supervision. However, there is a range of workplaces where wages and supervision are incompatible modes of obtaining effort. In ‘low supervision and high wages’ situations, increases in wages and increases in supervision may provide competing incentives for effort. This is because such situations are associated with ‘high trust’ workplaces, where increase in supervision causes resentment, associated with lack of trust, and results in labour shirking. The model suggests that the firm will operate two forms of workplaces: ‘primary’ sector – high wage, high trust, low supervision places; and ‘secondary’ sector – low wage, low trust and high supervision places.

High commitment models of efficiency wages looks for ways for overcoming the conflict expressed by the competing incentives model. High commitment models explore alternatives to close supervision, for example developing a set of norms and values to promote consensus and co-operation. This model is similar to the corporate culture models that emphasise how management can structure work culture and workers’ identity. The aim is to minimise conflicts between the firm and its workers, and to harness a cooperative and consensual relationship. However, such an organisational culture still remains hierarchical.

Radical economists argue that the conflicts of interest between employers and their workers are not resolvable. The analysis emphasises the class struggle over surplus value, labour exploitation, and unequal power relation. In these conflictual relations, employers possess greater powers than workers, as they have greater financial reserves and can manipulate the media and the state. Workers, in contrast, have little choice but to surrender to the dictates of their employers. In this context, workers’ collective body provides a countervailing power.

Yet, the firms resort to ‘bureaucratic control’ to overcome resistance, to impersonalise control. By instituting job categories, work rules, promotion procedures, discipline, wage scale, definitions of responsibilities, the managers establish an impersonal force of the ‘company values and policy’ as the basis for control. In addition, the technical and hierarchical nature of production means that workers can become lost within an automated system, driven by machines and separated from each other. However, while the system may divide and pacify the workforce, it can also act as a fertile ground for union activity and to organise resistance.

New models of work organisation have emerged that involve human resources management, lean production techniques, post-fordism practices. They focus on quality service, entrepreneurial skills, organisational flexibility, and responding to changes in consumer demand. There are three reasons for the break from the traditional mass production: the competitive need for labour flexibility; the performance depends on workers’ commitment; and employment and organisational practices are compatible with the overall strategy of the organisation.

To sum up, one strategy for organising the workforce replies on control, another on trust.