Unemployment explanations

I think that simple location is a massive friction and not fully accounted for. Look at how much commuting saps happiness. Look at how unwilling people are to relocate (above and beyond the costs of doing so). Look at how little companies recruit outside their immediate area.

I should note that whatever you think of this explanation, it argues that unemployment is not an economic problem. It views the unemployed as happily and rationally choosing not to work, which thus suits their preferences better and thus is of higher economic value (neglecting, of course, the cost of providing unemployment insurance).

This seems to be a non sequitur:
If a specific unemployed person in a given state of the job market maximizes their utility by not taking any job offer, it doesn't imply that they are happy of the current state of the job market. They may be unwilling to work at the conditions that are currently offered, but they may be willing to work at different conditions.

The most obvious and extreme scenario is when you are starving and all the jobs available to you are physically strenuous and yet offer starvation wages: you'd probably better off conserving energy and trying something else, including begging or stealing (if you are caught, you will go to prison where the state will feed you).

More generally, in the standard one-shot prisoner's dilemma, you are probably going to defect, since it is the choice that maximizes your utility assuming that the other player also tries to maximize their utility. This doesn't imply that you are happy to play the standard one-shot prisoner's dilemma.

This means that if some intervention gradually reduces everyone's salaries by 50%, then most people will still be willing to work.

If all employers could pre-commit to do reduce everyone's salaries by 50% and stick to their decision, and it was legally possible for them to do so, and they could somehow survive the massive strike that would ensue, then employees would probably have to swallow it. But even if employers could legally unilaterally change salaries, they compete with each other to get workers, so they can't realistically do that.

It seems that you forgot to mention another obvious possible explanation:
Some people may just be unemployable.

Some people may be unemployable in general because they are mentally ill or physically ill (though they are still accounted for as "employable" in the statistics because of underdiagnosis).
The extreme example would occur if starting from tomorrow we counted chimps as people. All of them would be unemployed and permanently so because they would be always unfit for work.

Some other people may be employable under different economic/technological conditions, but not under the current ones. The extreme example would occur if we had robots with a IQ-160-human-level intelligence that could be rented for 1/100th of the current minimum wage. Who would be going to hire humans in this scenario?

Another friction is the stickiness of nominal wages. People seem very unwilling to accept a nominal pay cut, taking this as an attack on their status.

Salary negotiation is a complicated signalling process, indeed. I'm currently an unemployed bioengineer and have been far longer than I would have liked, and consequently I would be willing and eager to offer my services to an employer at a cut rate so that I could prove my worth to them, and then later request substantial raises. But this is impossible, because salary negotiations only occur after the company has decided that I am their favorite candidate out of however many hundreds apply.

Worse, if I take the first move and openly (e.g. on my resume or cover letter) inform the company of my willingness to work on the cheap, they would assume that I am signalling being a very low-quality engineer, which is very far from the case.

Unemployment does very much seem to be an information trap.

Another friction is the stickiness of nominal wages. People seem very unwilling to accept a nominal pay cut, taking this as an attack on their status.

There's actually a major reason for the stickiness of nominal wages you've failed to account for: debt overhang. Any and all debts are calculated in nominal currency, not real currency, so if the labor market deflates (across-the-board salary drops), the debts of everyone who works for a living grow correspondingly more difficult to pay.

This explanation can be generalized: the higher the average (mean or median) level of debt among any given population, the more difficulty markets among that population will have in clearing, because market adjustments don't change the price-levels on time (hence debt: borrowing is buying time) that has already been bought and sold, forcing everyone to try and obtain the old prices (corresponding to prices when they took their loans) whenever they can.

This is why liberal bankruptcy statutes are one of the most important parts of a functioning market economy: future default risk is supposed to be a risk born by all prospective future lenders, and factored into the interest rate, rather than allowing newly-unpayable debts to drag down price movements throughout the entire economy.

(It's also why so many instances of bank bailouts lately have created "zombie" economies in which growth remains perpetually low: the misvalued debts were never cleared, but deflationary pressures have set in, so the real economies are being drained of larger amounts of real productivity than the debts originally corresponded to.)

Thus there seems to be little explanatory power in classical explanations that assume that people won't work because the salary is too low.

Except, of course, when the effective salary, after cost-of-living, relocation costs, training/educational-debt repayments, etc, is negative, in which case it is trivially irrational to take such a job.

(This actually explains more of the "skills gaps" than employers usually want to admit, since that would keep them from purchasing gold for the price of bronze.)

Well, let's consider, say, electrical generation plants that convert coal into electricity, in an isolated country. It is absolutely normal and there's nothing whatsoever mysterious that some fraction of the generating capacity would generally go unused. It's when you start abstracting out the generation capacity as a "good" traded on the market, that it becomes mysterious why it would be "unsold".

If you look at jobs, we have extremely severe discrimination based on origin (needs of citizens absolutely trump in almost all circumstances the needs of foreigners) on top of intrinsically very high cost of moving around or learning a foreign language, or learning a different skill, and regions are thus largely isolated. The labour is essentially a non moveable resource. If you have farmers struck in Antarctica, they will never be able to compete with farmers somewhere less hostile to farming, and they'll be unemployed and actively prevented from working anywhere else (because that sounds like it might drop the wages of the workers in those other regions). And they will be unable to price-cut anyone, because the fertilizer, fuel, and so on still costs the same for these guys, and their produce will cost more than anyone else's produce.

Is it really true that most markets clear, and the labor market is unusual? It seems to me that a lot of non-labor stuff also goes unsold. If I try to sell something, like my old phone, then I will probably observe that it goes unsold for at least some time. Is that also a mystery for economics?

Macroeconomics (by which I mean mainly the Keynesian/Monetarist schools) is built on the seeming trivial observation that the salaries of workers are the means by which they buy products, and that the sale of these products are the income of the firms that employ people. Therefore, if the job market doesn't "clear" it's not as simple as just waiting for salaries (the price of that market) to adjust. If salaries fall, this feeds into less cash for consumers, which generally implies less consumption, which feeds into less revenue for firms, lowering their demand for workers, etc...

How is this different between the labor market and any other market? If I try and fail to sell my old phone, that also affects my ability to buy stuff.

This essay by a business school prof argues that companies are irrationally demanding in who they choose to hire: http://www.upenn.edu/gazette/0113/feature2_1.html

Sticky wages are something it's quite possible to study in isolation from the business cycle and it should be no surprise that people have done so. I found a lot of enlightening things in that link, though of course it doesn't answer how much sticky wages end up contributing to unemployment. All the same, though, I don't think I would place much trust in economic models that don't include sticky wages at all.

The first idea to come to my mind, on reading this article, is that companies do not produce jobs and attempt to sell them to potential employees. Rather, potential employees produce labour, which they attempt to sell to companies (or, in the case of entrepreneurs, which they use to produce goods or services for sale).

Labour is... a very odd good. Most goods are produced, for a cost, and can then be stored and transported for a time before being sold at a profit.

Labour, on the other hand, can be produced at very little cost, but must be used in some manner at the time and place of production and can only be produced at a limited rate per person. Any hours that are not used are lost. Skilled labour is more complicated yet, as it comes in many varieties and most people are unable to produce most varieties (and those that can produce any given type will do so with varying degrees of quality).

This means, among other things, that the available supply of labour depends on the population of employable people; a new person, grown to an employable age, can produce new labour over and above what currently exists.

It seems likely that much of the difference between the job market and the ideal market can be traced back to just how different labour is from other goods.

Another class is excluded: Workers have the option to voice their opinon and thereby affect the market on a higher level. See Hirschman http://en.wikipedia.org/wiki/Exit,_Voice,_and_Loyalty

I mentioned this on LW here: http://lesswrong.com/lw/isk/a_voting_puzzle_some_political_science_and_a_nerd/

I like this post, because I find it very familiar, but it is familiar because it is reminiscent of the sorts of confusions and mix-ups that can result from half an economics education. And please allow me to push back on some points, to invite your further thoughts and considerations.

Just going in order, you treat classical economists as if they adhered to a revealed preference theory. That theory is Paul Samuelson's, introduced at the tail end of neoclassical economics. It cannot explain anything the classical economists did. And in general, those who are happy not to work are not unemployed, they are nonemployed. Only people who want a job but cannot get one are unemployed, so the revealed preference explanation cannot explain unemployment in any case.

The classical economists did indeed blame a lot of unemployment on union activity and price floors. They were not wrong to do so, either. Both quite predictably create unemployment.

Irrationality is not a charge that should be thrown around lightly in economics. There is nothing about the traditional model of rationality that says people cannot tie their status to their nominal wealth. After all, it is really more a question of whether others do so, isn't it? Nor is status necessary to invoke: workers are ignorant about the state of aggregate demand and their value to the company, so they use their coworkers and past experiences as references.

Some of the frictions you cite, such as changes in technology, are not frictions. Less productive workers are simply paid less, not unemployed.

Regarding all the difficulties of firing workers and changing jobs and so on, why doesn't a series of markets emerge to address this very problem? If one can turn unemployed resources into employed resources, then one can potentially profit.

Joseph Stiglitz on information and the invisible hand.

Janet Yellen on efficiency wages and unemployment.

Alchian has a good paper or three on related subjects, am thinking it's called "Information Costs," but Google brings up the wrong paper.

Macroeconomics is not based on the observation that people spend what they earn. That observation is pretty old, probably older than economics itself, if you take Adam Smith as the starting point. And neither Keynesians nor monetarists really exist today. We understand now that Keynes and Old Keynesianism are basically wrong, and New Keynesianism incorporates those criticisms into a new research program.

Monetary theories of recession and unemployment go back to at least the days of Thomas Malthus, Jean-Baptiste Say, and John Stuart Mill. Then you have Jevons's sunspots, the Austrian theory, and the rudimentary development of real business cycle theory as well, all before Keynes.

The circular flow model does not predict that a drop in spending creates a recession. The model just isn't meant to do that. Markets have equilibrating properties that pull firms to discovering what consumers demand and making full use of resources. And It should be pretty obvious from experience that that mechanism must break down somewhere. Otherwise the next time you lose a penny the economy will collapse. It just does not describe any theory of unemployment, not even really the underconsumptionist theory. See the permanent income hypothesis for one example--Milton Friedman's major break from Keynes.

You don't mention real business cycle or new classical theory. They are rather academically dominant or recently were.

Since, as you seem to know, spending is income, reducing everyone's income by 50% changes nothing. Everything goes down by 50%, and the economy is as it was before.

Of course people won't work when the pay is too low. Or, if you think otherwise, will you please clean my bathroom every day for a dollar? Or point me to someone unemployed who will? And employers will not hire when the cost is too high--though I don't doubt your bathroom-cleaning proficiency, I certainly wouldn't pay you $100 for the service.

You don't discuss the natural rate of unemployment at all.

No one is a Keynesian or a monetarist anymore, so most academic economists disagree with you about the business cycle. And I am not sure if even real business cycle theorists seriously will defend the argument that the oil shocks of the 70s caused a recession.

Yes, the media is pretty bad about this.

This is a fantastic post and I'd really like to see more like it, on any topic really.

It'd be really really cool if we could maintain them as wiki articles too, i.e. update them with new info. Is that feasible? Would you, Stuart, be interested in doing that for this topic?

Here's some comments from an economist blogger I follow (that found you thru Yvain's blog).

Do you know of any numerical models of economics which simulate and track each person (employer and employee) with their skills, preferences and such?

this is from henry george's book progress and poverty. he explains why there is the "enforced idleness" i.e. unemployment. i quite liked this part but i know its a bit dated and i don't really get economics. i think this would be one of those macroeconomic explanations for it.

" [22] All trade, let it be remembered, is the exchange of commodities for commodities, and hence the cessation of demand for some commodities, which marks the depression of trade, is really a cessation in the supply of other commodities. That dealers find their sales declining and manufacturers find orders falling off, while the things which they have to sell, or stand ready to make, are things for which there is yet a widespread desire, simply shows that the supply of other things, which in the course of trade would be given for them, has declined. In common parlance we say that "buyers have no money," or that "money is becoming scarce," but in talking in this way we ignore the fact that money is but the medium of exchange. What the would-be buyers really lack is not money, but commodities which they can turn into money -- what is really becoming scarcer is produce of some sort. The diminution of the effective demand of consumers is therefore but a result of the diminution of production.

[23] This is seen very clearly by storekeepers in a manufacturing town when the mills are shut down and operatives thrown out of work. It is the cessation of production which deprives the operatives of means to make the purchases they desire, and thus leaves the storekeeper with what, in view of the lessened demand, is a superabundant stock, and forces him to discharge some of his clerks and otherwise reduce his demands. And the cessation of demand (I am speaking, of course, of general cases and not of any alteration in relative demand from such causes as change of fashion), which has left the manufacturer with superabundant stock and compelled him to discharge his hands, must arise in the same way. Somewhere, it may be at the other end of the world, a check in production has produced a check in the demand for consumption. That demand is lessened without want being satisfied, shows that production is somewhere checked.

[24] People want the things the manufacturer makes as much as ever, just as the operatives want the things the storekeeper has to sell. But they do not have as much to give for them. Production has somewhere been checked, and this reduction in the supply of some things has shown itself in cessation of demand for others, the check propagating itself through the whole framework of industry and exchange. Now, the industrial pyramid manifestly rests on the land. The primary and fundamental occupations, which create a demand for all others, are evidently those which extract wealth from nature, and, hence, if we trace from one exchange point to another, and from one occupation to another, this check to production, which shows itself in decreased purchasing power, we must ultimately find it in some obstacle which checks labor in expending itself on land. And that obstacle, it is clear, is the speculative advance in rent, or the value of land, which produces the same effects as (in fact, it is) a lockout of labor and capital by landowners. This check to production, beginning at the basis of interlaced industry, propagates itself from exchange point to exchange point, cessation of supply becoming failure of demand, until, so to speak, the whole machine is thrown out of gear, and the spectacle is everywhere presented of labor going to waste while laborers suffer from want.

[25] This strange and unnatural spectacle of large numbers of willing men who cannot find employment is enough to suggest the true cause to whosoever can think consecutively. For, though custom has dulled us to it, it is a strange and unnatural thing that men who wish to labor, in order to satisfy their wants, cannot find the opportunity -- as, since labor is that which produces wealth, the man who seeks to exchange labor for food, clothing, or any other form of wealth, is like one who proposes to give bullion for coin, or wheat for flour. We talk about the supply of labor and the demand for labor, but, evidently, these are only relative terms. The supply of labor is everywhere the same -- two hands always come into the world with one mouth, twenty-one boys to every twenty girls; and the demand for labor must always exist as long as men want things which labor alone can procure. We talk about the "want of work," but, evidently, it is not work that is short while want continues; evidently, the supply of labor cannot be too great, nor the demand for labor too small, when people suffer for the lack of things that labor produces. The real trouble must be that supply is somehow prevented from satisfying demand, that somewhere there is an obstacle which prevents labor from producing the things that laborers want.

[26] Take the case of any one of these vast masses of unemployed men, to whom, though he never heard of Malthus, it today seems that there are too many people in the world. In his own wants, in the needs of his anxious wife, in the demands of his half-cared-for, perhaps even hungry and shivering children, there is demand enough for labor, Heaven knows! In his own willing bands is the supply. Put him on a solitary island, and though cut off from all the enormous advantages which the co-operation, combination, and machinery of a civilized community give to the productive powers of man yet his two hands can fill the mouths and keep warm the backs that depend upon them. Yet where productive power is at its highest development they cannot. Why? Is it not because in the one case he has access to the material and forces of nature, and in the other this access is denied?

[27] Is it not the fact that labor is thus shut off from nature which can alone explain the state of things that compels men to stand idle who would willingly supply their wants by their labor? The proximate cause of enforced idleness with one set of men may be the cessation of demand on the part of other men for the particular things they produce, but trace this cause from point to point, from occupation to occupation, and you will find that enforced idleness in one trade is caused by enforced idleness in another, and that the paralysis which produces dullness in all trades cannot be said to spring from too great a supply of labor or too small a demand for labor, but must proceed from the fact that supply cannot meet demand by producing the things which satisfy want and are the object of labor."

I think I'd be happiest as a NEET for the short term future but I'm scared it will become a lifestyle. Is it plausible that NEETS might get exterminated, forced into labour or left to starve/get-malnourished in Western countries like Australia within the next 50 years?

Are NEETs just passive aggressive and bad at externalising, like expressing anger which may motivate them to get stuff done?

Classical economics are just wrong. Because they have, and continue to, fail empirical testing. All economic theories do, which implies that we have no actually correct theories of economics, and are just wandering in the wilds of error.

Keynes is.. less wrong.. than the rest, but doesn't get applied very effectively or often in the real world because his recommendations have a strong tendency to step on the toes of the politically connected. My personal intuition is that Georgist economics are even more correct, but there is a dire shortage of real world testing for that because Georgism is even more offensive unto the people who buy politicians than Keynes. Same goes for some of the more interesting monetary theories. Banning fractional reserve banking and managing the size of the monetary economy directly via the printing press and taxation looks far more sensible and effective than what we are currently doing but would require bankers and the holders of government bonds to find ways to actually earn money rather than just collect interest.

Which leads to the observation that unemployment is useful to some people. The reserve army of labor is a political and social lever that elevates the status, income and power of employers and rentiers over labor. So as a matter of political economy, if unemployment can be maintained without causing disruptive protest... Not that I think anyone actually sits down and works out how to create unemployment, but actually doing anything about it is a much lower policy priority than preventing even very low levels of inflation for.. not very mysterious reasons.