Overview

A distinctive feature of most modern economies is that many job vacancies are filled from within, with firms often upgrading their incumbent employees rather than hiring new workers for the vacant position. This practice is typical of internal labor markets. In firms with internal labor markets (ILM) “new workers are used principally to fill specially designated entry jobs, which exist at various levels of the organizational structure. Other jobs are linked to entry jobs through promotion ladders and, hence, are filled from within” (Taubman and Watcher, 1986, p. 1189).

The emergence of internal labor markets in modern economies is usually justified by a number of reasons, ranging from the need to provide proper incentives to employees to the importance of human capital, from union behavior to bounded rationality and the reduction of transaction costs. The key feature of internal labor markets that we focus on in this chapter and chapter 2 is internal training, which in turn generates skill upgrading and internal promotion. In this chapter, we consider mainly training and skill upgrading. In chapter 2, we concentrate more upon internal promotion and hierarchical design.

The extent of internal labor markets in modern economies is difficult to gauge, as discussed in detail in chapter 3. Based on indicators such as tenure in the firm and earnings profiles, however, there is a wide consensus that internal labor markets are particularly developed in Japan, especially but not exclusively among large firms (see Aoki, 1988; Koike, 1988; Siebert and Addison, 1991).