Arnold Kling  

Unemployment: Why Don't Employers Fish More?

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I am trying to sort out my thinking on unemployment in the Recalculation Story. I think that a basic question is this: when workers lose jobs because a sector needs to shrink, this creates a pool of unemployed workers. Why don't firms fish in that pool? More thoughts below.

Engaging in market work means that you exploit comparative advantage. You do something you are good at. This gives you income, which allows you to buy goods and services that other people can produce more cheaply for you than you can produce yourself.

Being unemployed means that you do not engage in market work. Why not? Because you cannot find a firm that will pay you enough to make you believe that you are exploiting your comparative advantage.

In the spirit of the latest Nobel Prize that went to the economists known by the initials DMP, we can think of this as a matching problem. Presumably, there is some firm that will offer you enough pay to get you to leave the couch and go to work. But you do not take just any job, because you are waiting/hoping for a better match.

This DMP model is given a workout by Marc Bils, Yongsung Chang, and Sun-Bin Kim (older, ungated version here).

In the DMP model, there is something called "match rent," which is the profit a worker gets from being in a good match. What the Bils paper says is that it is hard to characterize match rents in a way that fits observed behavior.

If workers are being laid off in large numbers rather taking pay cuts, then the DMP model presumes that those workers had low match rents to begin with. Otherwise, they would have taken a pay cut to stay on the job. The fact that we observe layoffs rather than wage fluctuations suggests that match rents are low.

However, if match rents are low, then we should expect a relatively large amount of voluntary separations. Workers should often be on the brink of quitting to take a different job. We do not seem to observe this. (Or do we? The JOLTS data shows a lot of turnover. Also, there is a lot of churn that takes place within a particular organization--workers respond to internal postings, accept promotions, get reorganized, and so on.)

So Bils says that the DMP model has a problem, because it wants match rents to be low to explain fluctuations in employment, but it wants match rents to be high to explain a relatively low rate of quits relative to layoffs.

I suggest a different solution, which is that match rents are high but they can change drastically. My thinking is based on the Recalculation Story with Garett Jones workers. If workers are producing organizational capital rather than output, then there can be large changes in the value that firms place on workers, so that formerly high match rents can suddenly plummet. I ran that idea by Bils in an email, and he responded that it fails to generate a Beveridge Curve. If I am correct that unemployment is caused by job separations due to plunging match rents in some sectors, that should not cause the rest of the economy to stop posting vacancies. If anything, more vacancies should appear as firms try to fish in this large pool of unemployed workers. But empirically, vacancies decline as unemployment goes up.

So we are back to the question with which I began: in a recession, why don't firms fish in the pool of unemployed workers? Some possibilities:

1. Unemployed workers are "lemons." They do not generate high match rents, and they are not heavily committed to working, so they are liable to quit soon after you hire them. Bils in his email suggested that he and his colleagues have worked on incorporating something like this into a model.

2. The "wedge" between worker compensation and take-home pay is high. The wedge consists of taxes and also health care benefits that cost more to the firm than their value to healthy young people.

3. Hiring workers is an expensive capital investment. It takes a long time for a worker to learn enough about the organization to be able to contribute in a positive way.

I think my view of the world is as follows:

There are some workers for which match rents are low, and as Bils pointed out in his email we do observe that layoffs are more prevalent among workers who in general tend to have volatile work experience. In other words, layoffs occur most where match rents are lowest. Call these the weakly-attached workers.

However, in our complex economy, there are many workers for whom match rents are very high. For small shocks, these workers tolerate pay cuts (which can come in subtle forms, such as longer waits for promotion, more onerous work schedules, less autonomy, etc.) in order to keep their jobs. Call these the strongly-attached workers.

The Recalculation Story is that sometimes shocks can be large enough to cause match rents to drop so far that even strongly-attached workers experience layoffs. The layoffs mean that the drop in match rents is permanent, and this represents a significant drop in wealth. This is the sense in which Tyler Cowen is correct that we are now poorer than we thought we were.

Finally, although match rents are high, the cost of investing in workers is also high. In the DMP model, this might be expressed as saying that the matching technology is expensive. The expensive matching technology explains why firms don't fish more in the pool of unemployed workers.

Because the matching technology is expensive to operate, it takes a long time for some strongly-attached workers to get into good matches. Meanwhile, weakly-attached workers are affected by the wedge between compensation and take-home pay. This wedge has been rising over time. Moreover, there may be a tendency for the wedge to be higher in an economy where wealth has declined due to a fall in match rents.


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COMMENTS (12 to date)
Lewis writes:

Finally things get specific. Thank you!

fundamentalist writes:
Presumably, there is some firm that will offer you enough pay to get you to leave the couch and go to work.

Why? Why not assume the opposite: that there are not enough firms offering to pay anything at all?

If you disaggregate unemployment, you'll find that the industries hit hardest are always and everywhere capital goods producers using capital intensive processes, not consumer goods makers or retailers. Much of the capital invested in capital goods makers was wasted. I don't care how much GM has invested in its modern Saturn plants, it ain't worth nothing now. All of the workers who depended upon that capital have lost their jobs. Other industries have not expanded enough and bought enough new capital equipment to employ those workers.

It's not a matching problem at all. It's a capital destruction problem. There are no jobs to match the unemployed to.

Milton Recht writes:
3. Hiring workers is an expensive capital investment. It takes a long time for a worker to learn enough about the organization to be able to contribute in a positive way.
If 3 above is correct, then it is to a firm's advantage to fill an opening with an employee from a competitor. Both firms will then have the cost of hiring, instead of just the firm with the original vacancy. The first firm then also faces the capital investment decision of investing now, hiring now, or waiting to invest, hiring later in the business cycle. It should not be too difficult to see situations where a firm wants to increase the hiring costs for a competitor as it itself hires, but also wants to wait to do so to maximize the value of its investment in a new employee. If it hires out of the pool now, the firm loses that future opportunity to increase a competitor's cost.
fundamentalist writes:
3. Hiring workers is an expensive capital investment. It takes a long time for a worker to learn enough about the organization to be able to contribute in a positive way.

#3 should read "Expensive capital equipment must be purchased before companies can hire workers to run them."

Grant Gould writes:

3. Hiring workers is an expensive capital investment. It takes a long time for a worker to learn enough about the organization to be able to contribute in a positive way.

There is a saying in the software industry, often called "Brooks' Law", that adding workers to a late project makes it later. The reason is obvious: The folks already working on the project have to stop what they are doing to train up the new hire on the details of the project.

I suspect that something similar is the case in most industries: There are only particular times in the product cycle when adding a new worker can even theoretically increase output. In a recession, when everyone must be running flat out just to keep up, such opportune moments are few and far between.

Lord writes:

Some of your phrasing is unfortunate.

1. It is not the employees that are lemons, but the jobs they were doing. Employers had unrealistic expectations that were crushed by the market. They have to rethink what is worth doing. The lack of expectations of future profits is to blame (often due to overly tight monetary policy).

2. What is the reason to expect this to change suddenly? None.

3. Hiring is often a high capital investment, but not nearly so hire as to avoid layoffs in the first place. Employers are reluctant to commit, but once committed, are quick to abandon it. There is a real asymmetry here, and the difference is when projects commitments are made and when they are abandoned.

Joey Donuts writes:

Arnold:
Thanks so much for this post.

I recently moved to a small town in VT. The town has a published history including minutes from town meetings going back to the 1780's. Even in the late 1780's the town made provisions for the poor by taxing the residents (all of whom were subsistence farmers). However, they had a unique way of dispensing the taxes raised. They literally auctioned off the poor person to the lowest bidder for the persons care. (Most people that hear this story from me are horrified) which makes the telling of it all the more fun.

I think something like this auction would help lower the cost of the "fishing technology". Employers would examine the resumes of those receiving unemployment benefits and bid to employ those they wanted. Essentially they would be bidding to have the unemployment benefits or some portion of them paid to them as a subsidy of the wage costs.

Obviously, there would have to be provisions in the system to protect agains employers from gaming it. E.G. The employer fires everyone or just many and rehires them with a subsidy.

Currently the unemployed do the searching. The employers troll for employees by advertising jobs and receiving many more applications of un qualified workers which have to be waded through. The state employment offices could (with data bases that allowed for searching) provide employers with a low cost search and a subsidy. Furthermore, the cost of unemployment benefits would be reduced because some employees would be desired by more than one employer and the bidding would reduce the subsidy paid.


Don Lloyd writes:

The idea that a laid off worker had an opportunity to accept a lower wage is inherently unlikely for direct labor. The reality of any recession is that most firms will experience a substantial reduction in demand for their products, and therefore be in a condition of excess production capacity. It makes no economic sense for an employer to retain his entire workforce at even half pay when they can produce all the products that they can sell before lunch.

What makes economic sense is for the employer to reduce his capacity by starting with the workers who have the highest ratio of cost to productivity and lay them off. Since workers tend to increase their productivity faster than their wages, at least in the earlier stages of their employment, this is why average wages (of the remaining employed) do not tend to fall in a recession.

Regards, Don


Lord writes:

Except, since people are paid by their productivity, the actual criteria used differs. The better politically connected is a common one.

Chris Koresko writes:

fundamentalist: It's not a matching problem at all. It's a capital destruction problem. There are no jobs to match the unemployed to.

This suggested to me that the matching problem concept needs to be broadened: it's not just a need to match workers to their best use, but also a need to match capital to its best use. This idea seems to be a natural generalization of what Arnold has been describing.

Perhaps in the PSST framework, the reason that capital-intensive industries suffer most in a downturn is that it's harder to find a good new job for a Saturn plant than it is for a Saturn line worker.

Separate thought: If PSST is a good description of a recession, and a substantial part of the delay between a worker's loss of a job and starting a new one is simply the time it takes to identify the new job, then it is possible that the Internet should have a large impact on the severity and duration of a recession. I mean, if I lost my job tomorrow the first thing I'd do is log onto Monster.com and its competitors. This is much more efficient than searching newspaper ads, so I should be gainfully employed more quickly, right?

Doc Merlin writes:

I think a lot of it is due to the regulatory environment.

Here is an illustrative story I hear from my friends at large firms. A division within a firm will lay off a lot of workers, those workers will be given severance checks. A lot of those workers will be re-hired at great cost by a different division in that same firm.

Why didn't the firm just transfer people? It didn't just transfer people because firing for cause can result in very expensive lawsuits due to discrimination laws and such and it wanted to get rid of lots of bad employees. Laying off a substantial fraction of the division and then rehiring the best employees may be cheaper to the firm than long labor lawsuits.

fundamentalist writes:

Chris, that's a good way of looking at it. Capital is much less flexible than labor, so when variable capital, such as money, gets converted into fixed capital, such as plants and equipment, it's usefulness is very limited. When its usefulness ends it has nothing but scrap value.

For workers who lost their employment because the capital they used is now worthless, employing them again requires that surviving businesses save and invest in new capital.

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