This year’s Nobel Memorial Prize in Economics went to Peter Diamond, Dale Mortensen, and Christopher Pissarides for their work on “search theory,” especially as applied to labor markets. The irony is that their award-winning work provides peer-reviewed justification for a commonsense solution to high unemployment. Continuous extensions of unemployment benefits have the paradoxical effect of paying people not to find work.
According to the official Nobel press release, the newest economic laureates have designed models that “help us understand the ways in which unemployment, job vacancies, and wages are affected by regulation and economic policy.” The press release goes on to say: “One conclusion is that more generous unemployment benefits give rise to higher unemployment and longer search times.”
Most of the important results in economics make intuitive sense, once the issue is framed properly. Consequently, cynics often can’t believe people win the Nobel for something any small-business owner knows.
Yet for good or ill, the top-notch economics journals have become increasingly mathematical over the decades. Nowadays, economists can’t publish articles relying merely on common sense. On the contrary, their arguments must be codified in a formal model with all the bells and whistles.
This was the contribution of Diamond, Mortensen, and Pissarides. Specifically, they developed rigorous ways of modeling labor markets in terms of a search process.
In basic economics classes, the labor market is portrayed as a very transparent place where a worker knows all the job openings and the going wage rates. But in reality—and this is what the Nobel laureates stressed in their work—an unemployed worker doesn’t know which job openings are out there, and what potential salary he or she could make. After going through the interview process and receiving a job offer, a worker doesn’t know for sure if it makes sense to turn it down and keep interviewing for a better position.
Once we view labor markets from this perspective of imperfect information, it is straightforward to see how continuous extensions of government unemployment benefits will perversely exacerbate the problem. When weighing the pros and cons of accepting a job offer “beneath him,” a person will obviously be more inclined to remain unemployed if he’s receiving checks from the taxpayer. This is a perfectly obvious statement, and does not rely on moral condemnation of the unemployed person. People simply respond to incentives.
Pundits in favor of generous and indefinite unemployment benefits deride such a view as heartless “blaming the victim.” They lampoon conservative economists as claiming that workers are “enjoying a vacation” during this awful recession, instead of struggling to feed their families. After all, the pundits claim, there are no jobs to be had in this economy. Yet things are not nearly so black and white.
For one thing, the steady drone of monthly reports on “total employment” hides the reality that labor markets are always in flux. For example, if we dig into the Bureau of Labor Statistics’ latest report, we learn that in August 4.1 million jobs were created, while 4.2 million disappeared. Yet the media would typically report this simply as a drop in total employment. Most people probably imagined a very static working population that shed some of its members.
The more accurate view of labor markets sees that changes in total employment are simply the sum of job creation and job destruction. And in order for a job to be “created,” there must be some worker who accepts the job offer.