The current unemployment crisis through the lens of the 2010 Nobel

What’s at stake:The 2010 Nobel Prize in Economics has been awarded to Peter Diamond, Dale Mortensen, and Christopher Pissarides "for their analysis of markets with search frictions”. The trio pioneered research into the difficulties buyers and sellers often face in finding each other in the marketplace – and in particular, how that applies in the job market. These frictions derive from several sources, including imperfect information about trading partners, heterogeneous demand and supply, slow mobility, coordination failures and other similar factors.

An introduction to their work

Tyler Cowen argues that a key breakthrough was to realise that the problem was not how to explain unemployment per se but rather how to explain hiring, firing, quits, vacancies and job search and to think of unemployment as the result of all of this underlying microeconomic behaviour. This underlying behaviour involves not just workers looking for jobs but also employers looking for workers so explaining unemployment would require a theory of job search, worker search and matching and each aspect of the theory would have to be consistent with every other aspect; i.e. how much workers search depends on how much employers are searching (e.g. advertising) and vice-versa and also on the quality of matching and all of these considerations need to be addressed together. Cowen has a series on of posts that explains and summarises the contributions of each recipient: Diamond, Mortensen and Pissarides. 

Edward L. Glaeser writes that the prize manages both to honour timeless research on core economic questions and to highlight the ways in which economics addresses a most timely global problem. New paradigms emerge when reality crashes against theory, and that’s what brought us the search theory of Professors Diamond, Mortensen and Pissarides in reaction to the awful job the Economics 101 model was doing at explaining an American civilian labour force where nearly one-tenth say they want a job and can’t find one. Search models don’t just assume that buyers and sellers face a market-clearing price — they try to actually describe the process that determines that price. The work of these economists does not tell us how to fix our current high unemployment levels, but it does help us to make some sense of our current distress. Their models tell us that common wisdom — like the belief that higher unemployment benefits always increase unemployment — may be wrong and that policies that improve matching may have great value.

Shedding lights on current problems

Mark Thoma argues that their work helps us to understand how it is that there can be workers willing to work, firms that are willing to hire, and yet still have an elevated unemployment rate.

Barbara Petrongolo points out that a direct consequence of frictions is that, as markets typically do not clear; unemployed workers and job vacancies may coexist, even within very narrowly defined labour market segments. In particular, unemployment persists in equilibrium because before all unemployed workers find new jobs, some of the existing jobs break up, providing a new inflow into unemployment. This would predict that, after an adverse economic shock, it takes time to bring back unemployment to the pre-shock level, and thus recovery after a recession may be slow, even once new job opportunities start to arise.

Paul Krugman argues that the most relevant paper for the current debate on structural vs. cyclical unemployment is Blanchard and Diamond on the Beveridge Curve — the relationship between job vacancies and unemployment.  It shows that structural unemployment is a real issue, and that the volume of structural unemployment shifts over time. It also gives us a simple way to make the distinction about whether we’re mainly facing a rise in cyclical or structural unemployment: “The economy, however, is subject to two types of shocks with quite different effects. Changes in the level of aggregate activity cause rates of job creation and job destruction to move in opposite directions, while changes in the intensity of the reallocation process cause them to move in parallel.”

Mark Thoma argues that their work also implies that distinctions between cyclical and structural unemployment may not be particularly useful since cyclical unemployment can turn into a structural problem if search persists for too long and skills deteriorate — the deterioration in skills makes a match even less likely and hence creates a structural problem — and these workers become part of the long-term or permanently unemployed.

Bruegel Economic Blogs Review is an information service that surveys external blogs. It does not survey Bruegel’s own publications, nor does it include comments by Bruegel authors.