TWO coconut trees grow on the veranda of the Chitradurga employment exchange in India’s Karnataka state, where Kalandar Khan, a young member of the state civil service, holds jobs fairs and recruitment rallies. A snapshot on his mobile phone shows the veranda thronged with potential applicants for an ambulance-driver post. Another shows an event for Bharat Fertiliser: again, standing-room only. Mr Khan’s task—matching job-seekers from a variety of backgrounds to employers with quite specific requirements—is not easy. Many of those registered on his exchange lack the skills that employers require.
Mr Khan is hardly alone in worrying about a mismatch between workers’ abilities and the jobs on offer. Halfway around the world, some reckon that many unemployed Americans lack the skills needed to fill those jobs that are being created as the country emerges from recession. Others blame deficient demand for the country’s stubbornly high unemployment. Still others point to the housing bust, which has hampered American homeowners’ ability to move to where new jobs are being created.
Divergent as they are, these opinions about America’s persistently high unemployment rate are all based on a similar conceptual view of the labour market. It is seen as a mechanism for pairing people with jobs in which matching cannot take place instantaneously. This way of thinking about the jobs market and unemployment owes an intellectual debt to research on markets with search frictions carried out in the 1970s and 1980s by Peter Diamond of the Massachusetts Institute of Technology, Dale Mortensen of Northwestern University and Christopher Pissarides of the London School of Economics (pictured from left to right). On October 11th they were awarded this year’s Nobel prize for economics for their work.
The economists’ approach to these issues was a sharp break from the norm in the early 1970s, when standard economic models mostly treated labour as a commodity which had the worker’s wage as its price. There could be no unemployment in the simplest versions of these models, because wages would fall instantaneously to eliminate it. True, few economists took these simple models literally: lots of research was done to modify their assumptions and generate more realistic results, often by making it harder for wages to fall. But even the modified models took little note of data on how people flowed into and out of employment. The stretches of unemployment, the job hunts, the moves from job to job, the rate at which workers were fired or hired: all this was absent. Mr Mortensen argued that this needed to change. Investigating the way people actually went about finding jobs in an uncertain environment, he believed, should be a central concern of the analysis of labour markets. Initially working independently of each other—though Messrs Mortensen and Pissarides later collaborated fruitfully—this year’s laureates would go on to do just that.
The three economists built upon earlier work by George Stigler, who had studied the process by which people acquired information, and who won the Nobel prize himself in 1982. Pointing out that getting information costs time and effort, Mr Stigler argued that people would do so only as long as the additional benefits of having more information exceeded the additional costs of acquiring it. Mr Mortensen saw this framework as a useful way of thinking about labour markets, because finding employment in a decentralised labour market typically involves gathering and evaluating information on vacancies and wages.
Mr Diamond modelled this job-search process in a series of seminal papers written between 1979 and 1982. One was based on the premise that not all jobs are equally suitable for all workers. The first person offered a job might not be as good a match for it as the second or third person. So if every unemployed person grabbed the first job that came his way, the match between workers and jobs that resulted would not be optimal. By making it possible for workers to be more selective about the jobs they accepted, Mr Diamond showed, unemployment insurance would improve the efficiency of the labour market.
In another famous paper published in 1982, Mr Diamond showed how an economy in which different agents need to seek each other out could end up with several equilibrium rates of unemployment. In other words, there was no single “natural” rate: policymakers could in principle try for the equilibrium they most favoured. In a touch which Mr Khan in Chitradurga might appreciate, he explained his reasoning using the example of a tropical island where finding and trading coconuts was the only form of economic activity. Just as some people cannot find work, so some coconuts do not find a buyer. Economics students today still study the “Diamond coconut model”.
The best-known work by Messrs Mortensen and Pissarides, a joint paper written in 1994, is also a staple of economics courses. Whereas earlier analysis had tended to make assumptions about the rate at which job vacancies arose, the two figured this out from more basic assumptions about the incentives of workers and employers. Their results have particular resonance today: their model showed why unemployment would shoot up in a recession but fall much more slowly when a recovery began.
The work that earned this year’s Nobel prize was carried out decades ago. But with the unemployment rate in America stubbornly stuck at 9.6% 16 months after the official end of the country’s recession, it remains as relevant today as when it was done. Mr Diamond, for one, may soon have to apply some of the insights from his research to the real world. His nomination to the board of America’s Federal Reserve is still in limbo after some Republicans questioned his competence. Perhaps a Nobel prize will encourage them to revise their opinion.