The price of labour and understanding the causes of poverty

This paper provides a review of how questions in labour economics link to the central concerns of development economics in understanding the mechanisms that both create, and perpetuate, poverty in some countries and not others and in some areas within countries. The paper frames this link by asking what determines first the price of labour, then the nature of employment open to labour and finally discusses the links from the price of labour to incomes through the assets owned by the poor. The advent of micro data in developing countries has transformed our knowledge of what needs to be explained. While the price of labour clearly depends on education the links between incomes and education are much weaker than is frequently supposed. The finding from micro data that conditioning on a wide range of observable characteristics of human capital still leaves most of the variation in earnings to be explained suggests the importance of understanding what these other factors might be and how they may interact with human capital. One possibility is that markets are segmented so that individuals with the same skills earn different amounts depending on the sector in which they work. Another possible explanation is that the unobserved characteristics of workers are more important than the observed and that processes of matching and search lead to the outcomes we observe in labour markets. It is argued that these explanations are not mutually exclusive and that different processes may operate across labour markets both within and across countries. The review concludes by outlining outstanding research issues in labour economics where new models and data may well provide insights into explaining the extraordinarily diverse range of outcomes we observe for the price of labour in poor countries.