The theoretical foundation of industrial relations is based on the core principle that labor is

embodied in human beings and is not a commodity. The field's two central dependent variables are
labor problems and the employment relationship. This principle, combined with ideas from
institutional economics, is used to develop a theoretical framework that explains the nature of the
employment relationship and labor problems, as well as reveals shortcomings in related theories
from labor economics and human resource management.

The field has its roots in the nineteenth century, with researchers attempting to identify the core
principles that distinguish industrial relations from other labor fields and build upon these principles
to explain key labor/employment outcomes and processes. The most notable exemplars include
contributions by scholars such as Sidney and Beatrice Webb, John R. Commons, and Lujo Brentano.

Despite the century of effort and numerous books and articles on the subject of industrial relations
(IR) theory, there is relatively little impact or presence of this theorizing in the literature of the last
two decades. In this paper, the author aims to move the project of IR theory building and tool
development another step forward by making five contributions to IR theory.

First, the author uses historical analysis to identify the field's core theoretical and normative
principle—the proposition that labor is embodied in human beings and is not a commodity. Second,
the author develops a theoretical explanation for the twin "dependent variables" of industrial
relations, the employment relationship and its attendant labor problems. Third, the author uses the
theoretical framework as a platform for a wide-ranging critique of neoclassical labor economics and
human resource management. Fourth, the author utilizes this framework to deduce new concepts
and hypotheses about the employment relationship, including the delineation of the field's
"fundamental theorem."

Industrial relations (IR) has been defined both broadly and narrowly, with the original paradigm
focusing on the employment relationship as a critique and alternative to classical/neoclassical
economics. Early IR included collective bargaining, union studies, personnel/human resource
management, and labor/employment law. After World War II, most IR academics continued to pay lip
service to this broad definition but increasingly narrowed the focus of the field to trade unions and
collective forms of workforce governance. In recent years, some scholars argue that the IR field
should return to the broader employment relationship definition.

The IR field has not yet settled on its core organizing principle or concept, making theorizing difficult.
Some opinions drawn from the literature include rules of the workplace, job regulation, social
regulation of production, the employment relationship as structured antagonism, social regulation of
market forces, process of capitalist production, conflict of interests and pluralist forms of workplace
governance, class mobilization and social justice, advancement of efficiency, equity, and voice in the
employment relationship, collective representation and social dialogue, and representation and
political regulation of different interests.
Historical analysis reveals that at the time of the founding of the IR field, another proposition was
paramount: the core principle of industrial relations was to bring more stability, efficiency, justice,
and human values to the employment relationship. This labor reform project met many obstacles
and objections, including orthodox classical and neoclassical economics, which was widely accepted
and regarded as "orthodox." The principle of free trade and Say's Law were widely accepted lessons,
which applied to domestic and factor markets, including labor markets.

These points are fundamental to understanding the origins of industrial relations and its core
principle, which require that labor be treated as a commodity in a competitive market. A modest
excursion into the history of thought can demonstrate this contention and bring back into view the
intellectual foundations of the IR field now mostly forgotten.

Léon Walras, the founder of neoclassical general equilibrium (GE) theory, established the orthodox
position in his Elements of Pure Economics (1954). He believed that the focus of economic science
was market exchange and that the laws to which these purchases and sales tend to conform
automatically were determined by the market. Walras adopted the more general concept of a
commodity, which is crucial to the model of perfect competition, as prices and quantities are entirely
market-determined. When Walras came to factor markets, he modeled labor as just one more of N
commodities for which price and quantity are determined by demand, supply, and competitive
bidding in a perfect market.

Alfred Marshall, in his Principles of Economics, first asserted the general case that the normal value
of everything rests balanced in equilibrium between the contending pressures of its two opposing
sides. He applied this theory to labor, arguing that the human aspect of labor markets makes them
considerably less perfect than most commodity markets and that individual workers often bargain at
a disadvantage. The founders of industrial relations concluded that the unbalanced free trade labor
market model was a large contributor to the Labor Problem and sought to reform and reengineer it.
They sought to develop an example that "the standard competitive model views labor markets as not
fundamentally different in kind from product or other markets."

German economists took the heterodox position that some degree of market protection promotes
national welfare more so than unabridged free trade. HSE provided theoretical support for
Germany's pioneering programs in the 1880s of accident, unemployment, and old age social
insurance, which were widely regarded in the United States as an opening wedge for socialism and
outside the pale of good economics and wise social policy. Laissez-faire in labor was the rule,
evidenced by the fact that the United States did not even have a national child labor law until 1938.

The Industrial Relations (IR) school of thought emerged in the 1880s and influenced the American
school of institutional economics and its labor subfield, industrial relations. Early sociologists like
Durkheim and Weber sought to integrate social and institutional elements into economics, with
Parsons being a major source of ideas for his industrial relations systems theory. The German
tradition had a strong influence on Wisconsin labor scholars, who believed that laws could lead to
progress while preserving human betterment.

Richard Ely and Henry Carter Adams are considered forefathers of early American industrial relations.
Ely wrote the first proto-industrial relations book in America, titled The Labor Movement in America,
and predicted the masterful treatment of Sydney Webb and Beatrice Webb in their chapter in
Industrial Democracy. Adams, in his influential essay, is the first person to use the term "industrial
relations," arguing that it should be the purpose of all laws to maintain the beneficent results of
competitive action while safeguarding society from the evil consequences of unrestrained
competition.

Ely, Adams, and other rebels sought to create a more realistic, relevant, and receptive to institutional
reform. They founded the American Economics Association, which later coalesced into institutional
economics. John R. Commons was brought to Wisconsin in 1904, making Wisconsin the center in the
United States for the study of labor. Commons became the founder of labor economics and a co-
founder of American industrial relations, personnel/human resource management (HRM), academic
labor law, and institutional economics.

The "new economics" of labor, industrial relations, was based on alternative ideas and methods
found in HSE. IR came to Japanese universities after World War II largely from America, but the roots
go back to the 1890s when Noburo Kanai did graduate work in economics in Germany and took the
lead in founding the Japanese Social Policy Association. Commons and IE were also "proto-
Keynesians" in the 1920s and integrated Keynes into a "social Keynesian" model of labor markets.

The labor commodity principle and the "demand/supply" concept of employment were widely
rejected by labor reformers and early founders of industrial relations. The International Labor
Organization (ILO) was created in the same period (1919-1920) as the new field of industrial
relations, aiming to end political and industrial warfare. The first of nine principles enumerated in the
ILO Constitution reads: "Labor should not be regarded as a commodity or article of commerce." Early
IR academics uniformly rejected the labor commodity principle, citing Schumpeter and Keynes as
major influences.

Trade unionists also sought to replace a commodity theory of labor with a human conception,
arguing that the doctrine of humanity overrode all teachings of political economists and supply and
demand. The American Federation of Labor declared the Clayton Act of 1914 "Labor's Magna Carta,"
when the unions succeeded in inserting a provision that stated "the labor of a human being is not a
commodity or article of commerce." Progressive business people also condemned the labor
commodity theory and sought to replace it with a human theory. Businessmen, including John D.
Rockefeller, Jr. in the United States and Montague Burton in the United Kingdom, provided funds for
institutionalizing industrial relations initially in both American and British universities.
Two examples from historical literature illustrate the critical position progressive business people
took toward the labor commodity theory. The Report on Industrial Relations, issued by the
Merchants Association of New York (1919), lists three features of the industrial system that are not
compatible with satisfactory industrial relations, such as the law of supply and demand determining
wages and conditions of employment.

The theoretical foundation of Industrial Relations (IR) aims to identify and explain the central
research foci of the field, the employment relationship and its attendant labor problems, and
demonstrate that IR's chief present-day competitors (neoclassical labor economics and human
resource management) have deep conceptual flaws and do not adequately explain the employment
relationship. Neoclassical labor economics is the core of IR, which is the model of a perfectly
competitive labor market. This approach has been closely identified with the Chicago School, which
has been grounded on the proposition that observed prices and quantities as good approximations
to their long-run competitive equilibrium values.

Theoretical discussion builds on the employment systems framework in Kaufman (2004b), along with
ideas and concepts from the original HSE/IE, Karl Marx, and Ronald Coase. Linkages to branches of
modern mainstream labor economics, such as imperfect and social labor markets, incomplete
contracts, moral hazard, and principle-agent problems, will be evident and are in many respects
complementary to the IR perspective on employment relationships.

In keeping with the historical roots of original industrial relations, the resulting theory—certainly in
its policy implications—is a middle way between NLE and Marxist/radical economics (and sociology).
In this respect, IR accepts and uses various component parts of NLE, but at a paradigm level, it
cannot be integrated into the Walrasian DS structure of standard economics.

IE/IR does not reject NLE tools such as maximization, marginalism, and equilibrium. Instead, it
positions that NLE tools and models are useful in a subset of economic relations where the requisite
continuity, completeness, convexity, and stationarity conditions hold. However, they are not
universally applicable due to historical, social, and institutional elements violating them.

IE/IR does not reject NLE tools such as maximization, marginalism, and equilibrium but does not
reject them because historical, social, and institutional elements violate them. The downside of IE is
less mathematical tractability and more indeterminacy, while the upside is room for important
features of a human economy, such as entrepreneurship, path dependency, and strategy.

Industrial relations is a social labor economics that focuses on the exchange and use of human labor
power in an employment relationship embedded in imperfect markets and hierarchical firms. It
recognizes that labor markets and employment relationships are politically constructed, and core
economic concepts can only be specified once a regime of property rights is established by a
sovereign authority. The regime of laws and property rights determines "whose interests count" and
the distribution of benefits and costs of economic activity. Industrial relations is guided, regulated,
and supplemented by the Visible Hand of the state.

The theory is based on a complex model of labor markets and employment relationships, which are
politically constructed. The demand curves and supply curves determine the equilibrium wage and
employment level in the external labor market (ELM). The firm or other production unit is depicted
as a hierarchical system of command and control, with the chief executive officer and other top
managers at the top and employees at the bottom. The photo taken in 1915 at the Colorado Fuel &
Iron Co. represents the human essence of industrial relations and how the new science and practice
of industrial relations can restore industrial peace, create a more efficient and equitable employment
relationship, and save capitalism from destruction by its radical enemies or internal
dysfunctionalities.

Neoclassical economics has had detrimental consequences for the survival and growth of the
Industrial Relations (IR) field. The two paradigms are incommensurate and opposed, with Industrial
Relations focusing on labor problems as inherent outcomes of the employment relationship and
policy programs aimed at ameliorating or solving these problems through institutional interventions,
social re-engineering, and humanist ethical practices. The more one subscribes to the competitive
NLE model, the less validity and merit these parts of industrial relations have, making IR an empty
space.

In 1960, the Chicago School and NLE (modern labor economics) decisively displaced institutionalism
and banished the concept of labor problems, leading to the portrayal of outcomes such as
unemployment, discrimination, occupational segregation, rigid wages, and internal labor markets as
efficient equilibrium solutions generated by rational choice, competition, and demand and supply.

NLE critics dismiss special consideration to the human rights and interests of workers as normatively
tainted and non-scientific value judgments. Industrial Relations maintains that modeling workers as
commodities makes a normative and biased assumption, making social welfare a function of
consumption goods but not the quality of work life.

In conclusion, neoclassical economics has had fatal consequences for the survival and growth of the
IR field, as it is incommensurate and opposed to the field's territory, work, structure, management,
governance, outcomes, and the quality of work life.

The theoretical foundation of Industrial Relations (NLE) suggests that in a perfect competition world,
demand and supply optimally allocate resources, all sides benefit from trade, contracts are perfectly
enforced, and labor and capital are paid their marginal contributions to production. This leads to a
Pareto optimal outcome, where it is impossible to make one person better off without reducing the
welfare of another. Labor problems, however, have no theoretical place in NLE, and government
mandates are viewed with skepticism. The competitive model eliminates all labor problems and
renders ineffective and unnecessary all of IR's problem-solving tools, such as worker representation,
trade unions, labor law, social insurance, progressive employee management, and government
macroeconomic stabilization policy. The Mackenzie Kings of industrial relations (IR professors, HR
managers, union leaders, labor lawyers, mediators, central bank chairs, government safety
inspectors) have nothing to do or value to contribute in maintaining equilibrium in the employment
relationship. The message of NLE is that the firm and employment relationship are composed of
human beings, but the human aspect can be neglected in theory-building without substantive harm.

The text explores the labor market and employment relationships, focusing on institutions as social
constructs that define rules, constraints, opportunities, and influence preferences. The standard view
is that non-institutional labor law (NLE) is about labor markets and labor institutions (mainly unions),
while the institutionalized view (IE) holds that all labor markets and employment relationships are
"institutionalized." In a world of zero transaction costs, there is no economic function for law to
perform, making competitive price theory in effect a "non-institutional" economics. Institutions
structure and segment labor markets, leading Kerr to claim NLE price theory is mostly applicable to
"unstructured" labor markets while IR covers "structured" markets. The paper argues that the
Beckerian thesis is logically untenable in a human economy with positive transaction cost, implying
"social structure matters" as long claimed by IE/IR. The paper also discusses the division of labor
markets into firms and labor markets, highlighting the central components of the employment
relationship.

Neoclassical microeconomics, a central theoretical device in neoclassical microeconomics, has

evolved beyond the competitive model to include imperfect market problems and non-market
institutions. However, critics of the competitive model face a no-win situation, as criticizing it can be
seen as a simplistic dead horse. The competitive model assumes that labor is homogeneous, a
commodity. A critical analysis of this assumption leads to two conclusions: the neoclassical model is
the "empty space" for a logical explanation for the employment relationship, and modifying this
assumption to model the labor factor as "substantively human" yields an IE-based theory that
explains the existence of the employment relationship and its key features. Modern NLE becomes
nearly impervious to outside criticism because any alleged inefficiency or deviant observation can be
explained by a new model. This procedure introduces considerable ex post rationalization and
obfuscates identification of how real-world labor markets operate. The "substantively human" model
maintains fidelity to fundamental properties of real human beings, while bounded rationality (BR) is
used to explain the complex nature of labor markets.

The neoclassical demand-supply (DS) model is a crucial aspect of the competitive labor market, as it
suggests that if labor is differentiated, the supply curve of labor becomes upward sloping. This is
because firms are no longer indifferent to which unit of labor they purchase, implying a personal and
typically ongoing relationship between the employer and employee. This is not present with
commodity suppliers of wheat, oil, and so on.

In contrast, the foundation for IR theory lies in the empty shell of neoclassical DS theory. Since DS in
the external labor market cannot provide a determinate wage/employment outcome, firms must
close the terms of the varying degrees through management fiat and HRM policy. Industrial relations
recognizes that wages and other terms and conditions of employment are likely to be set to serve
the interests of employers, such as wages below the competitive level for infra-marginal workers.

There are numerous cleavages between NLE and IR with regard to competitive labor markets that
degrade the former and strengthen the latter. For example, if labor is human, then labor supply is
volitional, and wage rates are always and everywhere managed/administered prices, albeit shaped
and constrained by market forces.

The human essence of labor means that labor demand and supply curves are not independent
functions, wages are likely to have a large degree of rigidity, and labor markets are no longer self-
regulating. Firms are reluctant to cut wages in a situation of excess labor supply since doing so harms
morale and often reduces work effort and productivity more than proportionately.

In conclusion, the neoclassical demand-supply (DS) model and industrial relations theory have a
close intellectual link, starting with the influence of Commons' ideas on Keynes' General Theory.

The human essence of labor is a key concept in institutional economics, with ownership and property
rights being the foundation. In labor markets, firms typically own capital and land inputs but rent
labor. In a world of perfect competition, this distinction is irrelevant, as market forces ensure equal
terms and conditions for labor in either contractual mode. However, in the real world of imperfect
competition, economic rationality leads firms to give more attention and care to the resources they
own than to the ones they rent.

Industrial relations (IR) denies that a market system is self-equilibrating, and wage cuts principally
come from competitive threats to firm survival in the product market. In recessions, employees are
discharged by the millions, leaving society to bear the cost of labor maintenance. Commons (1934b)
made the transaction—the legal transfer of property rights—the fundamental unit of economic
activity.

For a labor market to be perfectly competitive and yield an efficient outcome, all margins on the
labor service sold by the employee must be completely specified, priced, and delivered to the
employer, which only happens if all dimensions of the property rights are fully covered in a complete
and fully enforceable contract. This assumption makes market exchange the preferred mechanism
for allocating and coordinating economic activity, eliminating all institutions except the market as
active forces.

There is another theoretical conundrum for the NLE commodity model of labor demand/supply:
perfect decentralization, or extreme individualism, where all coordination takes place through
markets, implying firms disaggregate into single person entities. This economy has no employees and
no employment relationship to study, and they obtain labor services from other firms selling labor
services in the form of intermediate goods in product markets.

The Industrial Relations (IE) theory critiques the logical foundation of the commodity labor DS model,
arguing that it has a deep logical contradiction. If the model of perfect competition in labor markets
and attendant demand/supply diagram disappears, the employment relationship disappears.
Conversely, if positive TC is postulated, labor markets are always imperfect and the demand/supply
diagram disappears. This critique is more fundamental and damaging than the usual market failure
argument, such as monopsony and externalities. The Commons/Coase emphasis on positive TC
provides a theoretical foundation for explaining not only the existence of an employment
relationship but also features of this relationship, such as the boundary line between external and
internal labor markets, the structure of alternative types of firm-level employment systems, and the
structure of national-level industrial relations systems.

The logical consistency of a theory is important for evaluating its scientific status and credibility for
policy analysis. The competitive DS model has become the accepted benchmark for labor policy
debates, as managers determine the boundaries and internal structure of firms and influence the
reciprocal boundary and structure of external labor markets. The IE/IR position is that it often fails
this test, at least without significant amendment.

The competitive model, often used in labor market analyses, is a controversial framework that can be
challenging for proponents of labor policies. Critics argue that the model's negative implications are
easily recognizable, while proponents must demonstrate the seriousness of market failures or social
concerns. This led to the establishment of the Industrial Relations Research Association (IRRA) to
promote a "social science" approach to labor/employment economics. Critics argue that the
competitive model and its free trade and laissez-faire implications are flawed when applied to labor
markets and employment relationships. Modern NLE, which no longer ascribes to the competitive
model and labor DS diagram as core theoretical constructs, has effectively triumphed in a century-
long battle between IE and IR. However, if proponents continue to believe that the competitive
model, DS diagram, and invisible hand story accurately predict labor/employment outcomes and
evaluate institutions and policy initiatives, the battle lines remain in place. This critique of NLE and
modern IR's other academic competitor, human resource management, highlights the need for a
more balanced approach to labor policy.

Industrial relations (IR) critiques orthodox labor market theory and engineering-oriented production
and management theories, arguing that labor is a human factor and the employment relationship is
a human relation. In NLE, firms are more than production functions; they are governance structures
or an "industrial government." Competition forces firms to adopt efficient governance structures and
internal HRM practices, ensuring fair implementation and enforcement. Competitive firms have no
power over workers, and if workers are dissatisfied, they can voice their displeasure at zero cost by
quitting.

IR argues that traditional capitalist firms' governance is likely to be neither efficient nor fair, and it is
not democratic. It also argues that governance systems should consider other welfare goals, such as
fairness in the workplace and opportunities for human development. The inefficient and non-
democratic nature of employment in traditional firms is due to positive transaction costs, imperfect
labor markets, and the legal power given employers to determine unilaterally how they manage their
business. Firm owners are "industrial monarchs" with relatively unrestricted rights to hire, fire, and
pay as they see fit, constrained in an unregulated labor market only by the imperfect threat of exit.

The focus on firms as governance structures leads to the concept of the internal labor market (ILM),
which diverges from standard economics.

The National Labor Relations (NLE) approach to problem-solving is flawed and incomplete, as it fails
to reconcile the idea that "all sides gain from trade" with the invisible hand story of an economy.
ILMs, which are based on the idea that all sides gain from trade, cannot be reconciled with a
competitive invisible hand economy due to large transaction costs and principle-agent problems
within firms. They also do not yield equilibrium outcomes in the broader sense of demand/supply
balance as in external labor markets.

IE/IR argues that ILMs are not equilibrium outcomes in the broader sense of demand/supply balance
as in external labor markets. Firms set up ILMs to promote greater work effort and deliberately ration
rewards and opportunities for advancement through non-price means, creating an internal situation
of persistent excess demand. This is because human rights are restrictions on trade, and enlargement
of human/labor rights has come only over the indifference-to-opposition of neoclassical economics.

IE/IR has a separate theory about ILMs, starting with the Commons/Coase distinction regarding
alternative modes of economic coordination. Production in an economy necessitates a division of
labor, which can be organized and coordinated by one of two mechanisms: competition among
autonomous actors in external markets using demand/supply and prices, or cooperation among
interdependent coworkers inside hierarchical firms organized and fostered by management-
constructed human resource management practices.

In real-life economies, production is coordinated by both competition and cooperation, resulting in a

mixed economy. Theorizing Industrial Relations (IE) identifies possible combinations of these models,
including perfect decentralization where production disagglomerates to single-person firms and
competition performs all coordination of the division of labor, and perfect centralization where
production agglomerates from a host of individual firms to the highest possible level. The relative
role of cooperation, Indirect Labor Markets (ILMs), and HRM increases as multi-person firms grow in
number and size.

The determinants of firm size are explained by Coase (1937), who suggests that firms grow when the
cost of market exchange becomes more expensive. Technological factors also play a role, as
economies of scale and internal efficiencies make in-house production cheaper than external
purchase. Independent variables that determine transaction costs and internal production
efficiencies are identified, with asset specificity being the principal variable.

IE provides a determinate account of firm size, focusing on the concept of employment systems (ES)
as a more firm-level version of Dunlop's concept of an "industrial relations system." An ES is the
configuration of structures, policies, programs, and practices that firms adopt to obtain and dismiss,
develop, motivate, coordinate, and govern the labor input to achieve organizational goals. The high
performance work system (HPWS) is an HRM intensive system that employs a package of
employment practices to achieve superior productivity and profits.

Industrial relations (IR) has evolved over time to focus on fostering positive employment relations,
high trust, and cooperation in production. This approach differs from the orthodox competitive
model, which views workers as commodities and work effort as locked in through complete
contracts. IR recognizes that cooperation and fairness are important active components to higher
firm productivity and performance, but they must be created through far-sighted managers,
progressive HRM practices, and supportive institutions.

IR also recognizes that taking the long view in employment relations and using progressive HRM
brings with it significant fixed and variable costs, such as more HR staff, employment security, above-
market wages and benefits, employee voice, and management discretion. Firms must weigh the
extra costs and decide on the kind of ES to have. Some firms find maximum profit from a "simple" ES
with a largely informal HRM program and considerable exposure to the external labor market, while
others maximize profit with a "factory" ES featuring tightly controlled behavior through finely divided
jobs, assembly line production methods, standardized HRM classifications, and a hire-and-fire
discipline.

In conclusion, IR has evolved to focus on fostering positive employment relations, high trust, and
cooperation in production to improve firm performance. This approach requires careful
consideration of the cost/benefit ratio of alternative ways to achieve a given level of cooperation and
fairness, as well as the potential impact on profitability and competitive position in the industry.

The distribution of employment practices and relations in firms is a bell-shaped pattern, with low
road employers offering unattractive jobs and little HRM, while the middle group is decent places to
work with a partially developed ILM and some formalized HRM practices. The top group is
considered "the best places to work" due to secure, challenging, well-paid jobs, well-developed ILMs
and HRM programs, and a variety of commitment practices.

The resource-based view of the firm (RBV) posits that external sources of competitive advantage
have largely eroded, and the remaining best option is to use HRM practices to develop highly
skilled/committed employees. However, the HRM–firm performance hypothesis is problematic, as it
suggests that firms should expand their HRM and ILM systems because they add to profits. This
implies that firms should expand in size and gradually move the economy toward the
Taylorist/Leninist workforce that competitors cannot easily purchase or copy, which promotes
management-centric models.

HRM theorists also introduce contingent factors that modify the "main effect" of HRM on
performance, which may not be linear but is almost always presumed to remain positive. Similar to
NLE, HRM also promulgates models that explain all market and non-market outcomes while claiming
the economy operates according to competitive invisible hand standards. On one hand, HRM
promulgates models that contain both "low HRM" and "high HRM" ESs, but the literature posits that
only the advanced HRM model is the highest performing.

The field of industrial relations focuses on the relationship between labor markets and firms, with
labor economics studying labor markets and HRM studying human resource management. The
theoretical framework presented in this text illustrates how economic performance varies with
different combinations of markets and management. The two upward-sloping lines, NLE and HRM,
graph the fundamental theorems of each field, with NLE predicting that economic performance is
maximized at point B at the Walrasian corner solution of perfect competition and all ELM, and HRM
predicting that performance is maximized at point A at the Taylor/Lenin corner solution of perfect
cooperation (or “perfect unitarism”) and all ILM.

The power of the IE/IR theory is that it demonstrates neither is true given one precondition: that the
model of the human agent has some degree of bounded decision-making. Given this condition, the
economy features positive total cost (TC), an employment relationship, and incomplete labor
contracts. Positive TC leads to a “mixed” or “industrial relations” economy featuring both ELMs and
ILMs, and a mix of competition and cooperation and adversarial and unitarist employment relations.

The maximum performance point will vary left or right across firms, industries, nations, and time
periods in response to macroeconomic conditions, workers’ characteristics, variation in the five
determinants of economic organization from IE theory, and other factors that collectively influence
the extent and nature of TC and economies of internal versus external production, giving rise to
different configurations of employment systems at both a micro and macro level.

Industrial relations (IR) is often viewed as an unattractive, obstructive, and performance-sapping

activity by both New Labour Economics (NLE) and Human Resource Management (HRM). These
models, particularly NLE, view the employment sphere through the lens of "perfect unitarism" and
"perfect markets," predicting performance levels of Points A and B. However, if the economy were
"all ILM" or "all ELM," performance with real people would not be the predicted maximum at Point A
or B but at Point D or E.

IR posits a real world of imperfect people, and capitalism and its institutions are imperfect. Two of
these institutions are the employer-employee relationship and wage method of compensation.
These institutions inevitably generate labor problems, and IR systems construct cooperation through
appropriate institutions to escape the "low performance/high conflict" outcome.
As competition in external labor markets increases, wage/employment instability increases, and
short-run cost-cutting pressure grows, undercutting firm viability and cooperation inside firms. An
improvement in performance may be achieved by moving away from corner solutions and towards
the IR interior solution at Point C with a mix of ELM and ILM, cooperation and competition.

IR has its own "fundamental theorem," which posits that the highest economic performance and
human welfare are achieved with a mix of markets and hierarchical organizations, a balance of
competition and cooperation, and a juxtaposition of individual initiative and profit-making with social
responsibility and government regulation.

Institutional labor economics (IR) is a theory that focuses on the relationship between competition
(ELM) and cooperation (ILM) functions faced by employers. It is derived from the regression equation
and argues that the NLE first welfare theorem is incorrect in an economy where people are less than
omniscient beings. IR's fundamental theorem suggests that the optimal efficiency level occurs in an
economy of imperfect competition, where some degree of labor protection for workers is consistent
with and sanctioned by "good economics." IR serves as a bridge between NLE and HRM, providing a
general equilibrium theory that demonstrates how the interaction between market and production
systems mutually determines employment outcomes. It also recognizes the long-run endogenous
relationship between market and organizational structure variables and suggests that the
performance maximizing level of an employment practice should occur at an intermediate level
between ELM and ILM=100%. IR is considered a "competition-cooperation frontier" and aims to save
the system from being destroyed by its excesses. It is essential for IR to prosper by translating into
concrete and insight-producing theorizing that spans the market/organizational interface.

The theoretical framework presented in this text contributes to the industrial relations field by
critiquing its competitors, modern labor economics and human resource management. It generates
insightful ideas, concepts, and hypotheses about the production system, highlighting the importance
of imperfect bargaining and efficiency wage models. The framework also demonstrates why
imperfect competition and labor protection policies are beneficial for society, the economy, and
workers. It also highlights the interdependence and tension between external labor markets and
internal production systems of firms.

The unique and value-added employment relations approach distinguishes the IR field from others.
This approach encompasses all aspects of work, the structure, management, governance, and quality
of work life. It is based on a human/social conception of labor and the human agent, recognizing the
strategic interdependence between imperfect markets and competition and imperfect organizations
and cooperation. The paper also emphasizes the importance of a welfare function that includes
consumers' interests, economic efficiency, workers' interests, and social/humanistic goals.

The paper suggests a holistic/integrative approach that draws from and endeavors to meld theories,
concepts, and techniques from all disciplines that touch on the employment relationship. Labor is
considered distinctively and uniquely human, and this fact is of strategic importance for theorizing
about the employment relationship and formulating and implementing practice. The Wisconsin
approach partially supplants and modifies demand/supply while giving greater emphasis to other
social and institutional factors.