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163

Unemployment

Search and matching models offer a straightforward explanation for average unemployment: it may be the result of continually matching workers and jobs in a complex and changing economy. Thus, much of observed unemployment may reflect what is traditionally known as fncffona/unemployment.

Labor markets are characterized by high rates of turnover. In U.S. manufacturing, for example, over 3% of workers leave their jobs in a typical month. Moreover, many job changes are associated with wage increases, particularly for young workers (Topel and Ward, 1992); thus at least some of the turnover appears to be useful. In addition, there is high tumover of jobs themselves. In U.S. manufacturing, at least 10% of existing jobs disappear each year (Davis and Haltiwanger, 1990,1992). These statistics suggest that a nonnegligible portion of unemployment is a largely inevitable result of the dynamics of the economy and the complexities of the labor markel.

Unfortunately, it is difficult to go much beyond this general statement. Existing theoretical models and empirical evidence do not provide any clear way of discriminating between, for example, the hypothesis that search and matching considerations account for one-quarter of average unemployment and the hypothesis that they account for three-quarters. The importance of long-term unemployment in overall unemployment suggests, however, that at least some significant part of unemployment is not frictional. In the United States, although most workers who become unemployed remain so for less than a month, most of the workers who are unemployed at any time will have spells of unemployment that last more than three months; and nearly half wiU have speUs that last more than six months (Clark and Summers, 1979). And in the European Community in the late 1980s, more than half of unemployed workers had been out of work for more than a year (Bean, 1994). It seems unlikely that search and matching considerations could be the source of most of this long-term unemployment.

Welfare

Because this economy is not Wahasian, firms decisions concerning whether to enter have externalities both for workers and for other firms. Entry makes it easier for unemployed workers to find jobs, and increases their bargaining power when they do. But it also makes it harder for other firms to find workers, and decreases their bargaining power when they do.

2"See also the literature on sectoral shocks discussed in Section 4.10.

not suggest that they crucially change the cycHcal behavior of the wage and employment.



As a result, there is no presumption that equilibrium unemployment in this economy is efficient. In one natural special case, for example, whether equilibrium unemployment is inefficiently high or inefficiently low depends on whether y, the exponent on vacancies in the matching function (equation [10.68]), is more or less than one-half (see Problem 10.17).

Such ambiguous welfare effects are characteristic of economies where allocations are determined through one-on-one meetings rather than through centralized markets. In our model, there is only one endogenous decision-firms must decide whether to enter-and hence only one dimension along which the equilibrium can be inefficient. But in practice, participants in such markets have many choices. Workers can decide whether to enter the labor force, how intensively to look for jobs when they are unemployed, where to focus their search, whether to invest in job-specific or general skills when they are employed, whether to look for a different job while they are employed, and so on. Firms face a similar array of decisions. There is no guarantee that the decentralized economy produces an efficient outcome along any of these dimensions. Instead, agents decisions are likely to have externalities either through direct effects on other parties surplus or through effects on the effectiveness of the matching process, or both (see, for example, Mortenson, 1986).

Tills analysis impUes that there is no reason to suppose that the natural rate of unemployment is optimal. This observation provides no guidance, however, concerning whether observed unemployment is inefficiently high, inefficiently low, or approximately efficient. Determining which of these cases is correct-and whether there are changes in policy that would lead to efficiency-enhancing changes in equilibrium unemployment-is an important open question.

10.9 Empirical Applications

Contracting Effects on Employment

In our analysis of contracts in Section 10.5, we discussed two views of how employment can be determined when the wage is set by bargaining. In the first, a firm and its workers bargain only over the wage, and the firm chooses employment to equate the marginal product of labor with the agreed-upon wage. But, as we saw, this arrangement is inefficient. Thus the second view is that the bargaining determines how both employment and the wage depend on the conditions facing the firm. Since actual contracts do not spell out such arrangements, this view assumes that workers and the firm have some noncontractual understanding that the firm will not treat the cost of labor as being given by the wage. For example, workers are likely to agree to lower wages in future contracts if the firm chooses employment to equate the marginal product of labor with the opportunity cost of workers time.



"contract

FIGURE 10.8 Employment movements under wage contracts

Which of these views is correct has important imphcations. If firms choose employment freely taking the wage as given, evidence that nominal wages are fixed for extended periods provides direct evidence that nominal disturbances have real effects. If the wage is unimportant to employment determination, on the other hand, nominal wage rigidity is unimportant to the effects of nominal shocks.

Bils (1991) proposes a way to test between the two views (see also Card, 1990). If employment is determined efficiently, then it equates the marginal product of labor and the marginal disutility of work at each date. Thus its behavior should not have any systematic relation to the times that firms and workers bargain. A finding that movements in employment are related to the dates of contracts-for example, that employment rises unusually rapidly or slowly just after contracts are signed, or that it is more variable over the life of a contract than from one contract to the next-would therefore be evidence that it is not determined efficiently.

In addition, Bils shows that the alternative view that employment equates the marginal product of labor with the wage makes a specific prediction about how employment movements are likely to be related to the times of contracts. Consider Figure 10.8, which shows the marginal product of labor, the marginal disutility of labor, and a contract wage. In

This is not precisely correct if ttiere are mcome effects on ttie marginal disutility of labor. Bils argues, however, that these effects are unlikely to be important to his test.



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