Tuesday, February 7, 2012

Unemployment and labour surplus

Daniel Kuehn makes a point that is often overlooked in discussions of labour markets and unemployment:
To be in a labor surplus, you must (1.) have a reservation wage that is equal to or lower than the market wage, and you (2.) have to be jobless. Only the second criterion is involved in your classification as being "unemployed" - the phenomenon we allegedly care about and the data which we look at. We don't know how many people satisfy (1.) and (2.) - we don't know how many people comprise a labor surplus in this country. Nobody seems to have cared enough to even think about how to collect that data. We don't know if that number is cyclical or not. We don't even know if our unemployed uncle or unemployed friend is in that labor surplus or not. And we don't seem to care about that. The social fact we seem to care about is unemployment, not labor surplus. To be unemployed, it's perfectly possible to have a reservation wage above the market wage (and it's not even clear exactly what this means, since one person's labor can be sold in multiple labor markets). Nobody associated with the Current Population Survey will ever issue a survey to you asking you what your reservation wage is. It has nothing whatsoever to do with the phenomenon of unemployment. Unemployment is not the same as labor surplus.
It is possible to have a reservation wage below the market wage and be unemployed if you are not permitted to offer your labour at rate at or below the rate at which you could get a job. This is the basis for the standard criticism of minimum wages.

Labour markets are generally not spot markets: that is, jobs are for varying lengths of time (including being indefinite in duration). This matters for both sides of the exchange. An employer typically not only wants someone productive, they want someone who will stick around for a reasonable time. This is where that dreaded phrase “over-qualified” comes in. An employer is not going to invest effort assessing and training an employee who is fairly clearly going to be off as soon as something better comes along (and has a significant range and degree of “better”).*

When discussing labour markets, it is never sensible to consider only one side of the employment transaction.

Labour is highly heterogeneous: people vary considerably. An employer takes risks employing someone; the smaller the employer, the greater the risks. If you raise the risk of employing people without increasing the benefits, you lower the level of employment. This is the problem with “unfair dismissal” laws: they greatly increase the risks of hiring people so discourage employment, particularly the employment of the marginal. Meanwhile, well-connected folk with good credentials and a solid employment history become even more favoured by such laws. Naturally, such folk think “unfair dismissal” laws are a great idea, a mark of a “compassionate” society.

Actually, it is using ostentatious compassion to put the boot into the underprivileged, a common modern game which particularly common in Europe, which is why their labour markets are typically so disastrous for young folk (particularly young members of out-groups).

That people vary so much is also why the most important labour market intermediary is “friends, relatives, acquaintances”. The employer may not know anything about the offered person directly but they can consider the recommender, and the relationship they have with them, and judge matters accordingly: in effect, the recommending intermediary becomes a proxy “guarantor” of the prospective employee.

So much of commercial activity is about techniques to deal with risk, and labour markets are no exception.

* It has also been pointed out to me that it makes a great cover phrase for an employer who does not want to hire someone for another reason.

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