In search of search theory

This is going to be a long and wonkish post, so I’ll just give the dot-point summary here, and let those interested read on below the fold, for the explanations and qualifications.

* The dominant model of unemployment, in academic macroeconomics at least, is based on the idea that unemployment can best be modelled in terms of workers searching for jobs, and remaining unemployed until they find a good match with an employer

* The efficiency of job search and matching has been massively increased by the Internet, so, if unemployment is mainly explained by search, it should have fallen steadily over the past 20 years.

* Obviously, this hasn’t happened, but economists seem to have ignored this fact or at least not worried too much about it

* The fact that search models are more popular than ever is yet more evidence that academic macroeconomics is in a bad way

In search of search theory

Following the most recent Internet dust-up over the state of macroeconomic theory, I’ve been thinking a bit more about search models of unemployment. I first ran across these models when I was a student in the 1970s, a period of very high unemployment.

The basics of search models are simple and seemed, at least in the 1970s, reasonably realistic. Workers can look for jobs in various ways, all more or less time-consuming: looking at help wanted ads (which used to come out twice weekly in Oz), cold-calling potential employers, and asking friends and relatives to look out for openings. Since workers aren’t fully informed about the labour market, it doesn’t (at least in a good market) make sense to accept the first offer that comes along. Rather, it’s worth looking until you have a good idea what wage the market is willing to pay, then taking a job at that wage.
What was new about the search theories was the idea that this process could explain not only the inevitable frictional unemployment, but also cyclical unemployment associated with recessions. Various different ideas come into play here. First, the models imply that if there is a sudden but temporary shock leading to large-scale job losses, it will take some time to return to full employment (or ‘normal’ rates of unemployment). Second, economic shocks may create more uncertainty about market wages, leading workers to search longer.

The Internet changes all of this. It’s possible to find all the publicly advertised jobs in any given field, anywhere in the world, in a matter of seconds. With a little more effort, it’s possible to get lots of information about firms that may be hiring, even if they haven’t advertised vacancies. And, much more than in the past, its possible to get lots of information about potential employers, to assess whether the jobs they have on offer are in fact likely to be good ones.

With such a massive improvement in the efficiency of search we’d expect to see two things:

(i) shorter time spent searching, and therefore lower unemployment; and
(ii) better matches between workers and jobs, which should increase productivity and wages, and reduce subsequent quits and fires.

Both predictions were made in the early years of the Internet and, at least until 2008, the general view was that they were proving correct, though more slowly than had been expected.[^1]

But experience since 2008 has been completely the opposite of what a search model would predict. Unemployment rates have risen and employment rates have fallen. Worse still, the duration of unemployment has increased greatly. And there’s no evidence that this has been offset by an improvement in matching. Rather, lots of people have been forced to accept jobs that make little use of their education and experience, suffering wage losses as a result.

What has been the response of academic macroeconomists? As far as I can tell, almost nil. I was prompted to write this post by the debate over Kartik Arthreya’s Big Ideas in Macroeconomics. Responding to my observation that the word ‘unemployment doesn’t even appear in the index, Steven Williamson pointed out that Athreya spends several pages on the general properties of search models [^2], presenting them as the primary basis of unemployment theory. And Athreya seems to be on the money here. The Economics Nobel (yes, yes, Bank of Sweden etc, I know) is a lagging indicator, but the 2010 award to search theorists Diamond, Mortensen and Pissarides certainly does not indicate a view that such models are fundamentally flawed.

Athreya acknowledges the problem, sort of, by saying that “search is not really about searching” and observing that, if it were, the Internet should have reduced search costs. But if search isn’t about searching, what is it about? Athreya doesn’t say, and his brief discussion of housing markets doesn’t get us far – these are much more location-specific than job markets, and the Internet hasn’t changed the process all that much.

If search models aren’t the right way to think about unemployment, what is the right way? The simple answer is that unemployment is primarily a problem of macroeconomics not of labor markets. If aggregate demand is far below the productive capacity of the economy, workers will be unemployment and capital will be idle.

But there is still a puzzle here, one that search models were designed to solve. Why doesn’t competition between unemployed and employed workers work quickly to reduce wages to the point where demand equals supply and where there is no involuntary unemployment [^3]? The problem seems not be, as search models assume, that employers and potential workers don’t know about each other. Rather, it’s that employers can’t easily use the threat of new hires at lower wages to drive down the wages of existing workers (of course, this happens, but it’s clearly costly and risky in terms of worker morale). There’s quite a lot of literature looking at this, and I’ll try to post on it another time.

[^1]: Simple models of search can’t rule out cases where only one of these effects is seen. For example, the improvements in the quality of matches might be so great as to encourage people to spend even more time looking. But that doesn’t seem very plausible. It would imply a big increase in productivity and wages that hasn’t been observed. Here are a couple of references

Autor, D. H. (2001): Wiring the Labor Market,” Journal of Economic Perspectives, 15, 25-40.

Krueger, A. B. (2000b): The Internet is lowering the cost of advertising and searching for jobs,” The New York Times, July 20.

[^2]: With his characteristic grace, Williamson also pointed out that another blogger had also observed the absence of standard macroeconomic topics in Athreya’s index and accused me of plagiarising this point for my own review. As any reviewer knows, the index is always the first place you look in a book, so its unsurprising that the oddity of Athreya’s jumped out at two of us.

[^3]: The same question applies to capital, though it seems to be asked far less often. Recessions and depressions are characterized by idle factories and farmland, empty offices and shuttered shops. Competition between the owners of these assets should drive the associated rents down to a level where supply equals demand. In fact, however, the adjustment process seems mostly to rely on scrapping or depreciating enough of the existing stock to remove the excess.

37 thoughts on “In search of search theory

  1. I’d suggest worker expectations play a role. Speaking as someone who is ‘between opportunities’ I’m not planning to accept a pittance and a garbage job in exchange for the thirty-plus years of experience and multiple degrees that I bring to the table. Enhanced abilities to search keep my expectations higher and my personal ‘friction component’ higher.

  2. Recommenting what I put at Crooked Timber:-

    I have previously suggested that there could well be an externality in the labour market that encourages unemployment. In case anyone is interested, my most recent material on this on the internet is here.

  3. Hi John,
    Could I clarify? Are you saying that the ‘search theory’ now shows that there are not enough jobs for the people looking for them? Are you also saying that there are not as many jobs as the productive capacity of the Australian economy should generate, were it not for some unknown factor?

  4. Follow the money.

    The search engines take money from employers to advertise their services. It isn’t in their best interests to have the employer find someone immediately, because that leaves the chance of a second round of advertisements, and hence more revenue. Even better if the employer takes someone who is very poor, which means multiple rounds of advertising for their replacement due to being somewhat gun shy.

    The next thought is if that is the case why doesn’t an efficient service replace the current ones. Which degrades down to a first to market and advertising dividend problem.

    The case is mirrored with dating sites, of which there is somewhat more literature. The same conceptual trap, with clients signing up until they have found a partner then lapsing. A highly efficient site would therefore go out of business well before the “promising but never delivering” sites.

  5. @Veltyen most of the ads on employment sites are from agents who only get paid when they place someone, so they would be very sensitive to the success of the advertising site they use, especially as candidates and positions are often not exclusively represented by one agent. What steps do you think advertising sites are taking to be less efficient?

  6. It could be argued that the efficiency of job search has been matched by the efficiency of job creation.

    Anyhoo it seems comparing jobs early 20th C to now is a bit like the proverbial apples with oranges, as each ditch digger is replaced by a machine a new barista is born.

  7. I’m with 2 tanners on that — in that expectations may play a decent role. However, I think it’s more complicated as simply finding a job that might happen to be your best match, for example, doesn’t mean you personally understand that, so you might hold out for any number of reasons, and I can’t see why the same wouldn’t be true of employers (i.e., employers and job-seekers may have unrealistic expectations which they act upon). There’s also a myriad of other factors as to why people don’t find jobs easily that psychologists like to talk about, many of which probably have a quite decent ability to predict job success for some groups (e.g., mental health, literacy levels, ability to speak English, how personable you are, age, social biases… etc.). Given this, it would be rather surprising if any one factor explained a lot of the data, and thus whilst improving matching might well help people, it’s hard to see why it would be the be-all-and-end-all factor of interest.

  8. @Veltyen
    we used to have a system for matching employers & employees that worked quite well, CES.
    Sometimes government not only does things better it does it cheaper or at least at no extra cot on balance.

  9. The current government has decided to take the expectations of the (prospective) employee out of the equation. You must take A job doesn’t matter what. Of course this only applies to those wanting unemployment benefits. I have to ask, do they think that anyone, in those circumstances, is actually turning job/s down?

  10. When I was unemployed in the late 70’s and some of the 80’s, I used to justify my idleness by thinking that if I got a job, someone else would miss out. Since I was looking to work in the Public Service, this was indeed true.

    The effect on wages of the threat of replacement is very real. I know a programmer at IBM in Perth who has not had a pay rise for 5 years. He’s good at his job, and they haven’t retrenched him yet, but when one of his co-workers quit, their section was offered several Indian programmers to replace him.

    But on to this search theory. I used to live in share houses. At regular intervals you’d have a vacancy, and would advertise to fill it. Then you’d talk to all the interested people and chose one. After doing this for several years I came to the conclusion that I had zero skill at picking people to share with, and I was not alone. Economic necessity meant that rooms never stayed vacant, but if I’d been richer it would have been tempting to wait longer for the ideal candidate to turn up.

  11. What happened to Stiglitz’ efficiency wages theory of unemployment? It relies on asymmetric information to the disadvantage of the employer,who doesn’t know whether a new recruit will be conscientious and pleasant or not (she can find out quite well about skills). So instead of picking a new pig in a poke, it pays to give competent existing employees bonuses and overtime. So wages never reach the market-clearing equilibrium: workers with jobs work longer hours than in the equlibrium, and the “reserve army” waits outside.

    Stiglitz does not SFIK consider the converse information asymmetry affecting prospective workers, who don’t know whether the prospective employer and her supervisors are competent, decent and honest or sadistic and incompetent crooks, and so hesitate and/or demand higher wages to compensate for the risk. Presumably the Internet has reduced the second asymmetry but not the first.

  12. employers can find out lots about applicants on the internet if they’re using their real names. they can search out their twitter feed, their face book, the comments they make at blogs and which blogs they comment at and what they say there on which topics. as part of their cull. i remember when employers were allowed to say in their ads: “long hairs need not apply”, they need not say that any more, since they can screen all their applicants pre-interview, long or short haired, with the internet. -a.v.

  13. @alfred venison

    That relies on people being foolish enough to have public profiles, or the employer/recruiter spending the time to form links with prospective candidates (or, in the USA, simply demand username and password for every social media site as a condition of application).

    Given the rich set of associates I have on social media with names like “Kay Oss”, “Kit Ten” and “Oh M Gee”, I suspect that a potential employer would find it frustrating to search for them. I’ve also had someone this week ring my workplace after I reached out to them on LinkedIn to say “who are you?” and then feel embarassed because they knew me quite well a few years ago but hadn’t linked my photo to my social name.

  14. It seems to me that “job search” is not quite the right framework of discussion. Along with “job hunting,” the image is of a hunter-gatherer going out to find a “thing” that is sitting there, waiting to be dug up like a potato, or shot down like a deer.

    But it seems to me that job hunting these days is more like courtship, and a very unequal and unpleasant courtship at that. Unemployed people take courses teaching them job-courting skills, which in a competitive market drives them to more and more extremes of plumage and fluttering dance and complex songs, but which extra effort, even if successful, still nets them the same job they would have had fifteen years ago, or a worse one, for far more effort.

    Worse yet, there are far fewer female birds of paradise (jobs) than males (unemployed people,) and the females are not even driven by a biological clock — they can paint their nails and survey the males for months, they’re in no hurry. Right now, a job hunter practically has to be a Nobel laureate bird of paradise to tilt the scale in his favour.

    Noni

  15. Surely, the main fault is in applying a simplistic model (any simplistic model) to a complex system. Which is more nearly true, a supply model of unemployment or a demand model? The answer is “either” or “both”. It depends of the overall condition of the economy. I am assuming here that “search” is a component of supply. There are clearly other components of supply like experience and training.

    Unemployment depends on any number of factors in the economy, in the society and in the biosphere. It would be important to list a few key ones as a start.

    1. Labour supply.
    2. Labour demand.
    3. Broad macro-economic policy.
    4. Technology impacts.
    5. Social expectations.
    6. Insitutional arrangements.
    6. Supply of resources, waste absorption (or adsorption? *) and bioservices by the environment.

    These are just a few off the top of my head. I am sure that one simplified model (job search) is not going to explain the complex system. The main problem with orthodox economics as I see it is that it wants to abstract too far from the real world. It seems to think economics is free-standing from the physical world and free-standing from the broader social and civilizational world.

    * Note: I leave it to the chemists to say which word (or both) is correct to use in this context.

  16. Bill Mitchell always gives a good survey and summary when Australia employment data comes out.

    http://bilbo.economicoutlook.net/blog/?p=28371

    This survey is comprehensive, objective and makes no significant mention of MMT which Bill Mitchell reserves for his more polemical posts.

    My personal take is that the flatness of the AUS and USA economies and the almost recessionary state of the EU is related to bad macro-economic policy for sure but it also goes deeper than that. In a world of constrained resources (we are getting close to constraints) the developing world, especially China, is outbidding the developed West for key resources, especially energy. China can do this because it gets more production bang for its energy buck due to its low wage structure.

    Being outbid for more expensive, but still available resources, is the prelude to genuine global resource shortages. Relatively soon, in historical terms, the world economy will flatten and shrink due to resource shortages.

  17. I think it’s that with IT and automation the amount of work to do has declined, but society can’t bring itself to admit that each of us only has to work a couple of hours a day to get necessary things done.

    To much effort to think how to to give people the funds they need to exist (and to continue to consume the products of industry) without having the social identity of a full-time job.

    Another thought, perhaps the employed underemployed search jobs on the internet at work and parlay themselves into better jobs (employers always preferring people who are in employment), taking away all the real jobs from the unemployed.

  18. According to “social researcher Mark McCrindle, adding the cost of pregnancy, private tutoring, sports and dance classes, and electronics for kids, and considering the average child now stays at home until 24, the real cost to the Australian parent of raising a child is $1,028,093.”

    Let us assume the real cost is $1,000,000. Thus each 24 year old or older, in addition to all valuable human and social qualities and abilities is a self-actuating, self-repairing, self-locomoting, self-replicating (in a couple), intelligent, learning machine with a wide array of algorithmic, heuristic, servo-motor and sensor capabilities. In other words, a very complex and useful machine (when considered just as machine) which costs a million dollars a pop to develop to full capability.

    Then we scrap it (high youth and young adult unemployment) and import expensive machinery from overseas to do what these people could do. Of course, this is not true in all cases. Many machine can do what humans cannot. Equally, it is arguable that many jobs are done better by humans than by machines or at least as well done.

    So where is the logic and economics sense in throwing all these million dollar machines (humans) on the scrapheap? Let alone discussing the inhumanity of it. Our system can be seen to be crazily wasteful when you look at it properly.

  19. John, the reason that competition between the employed and unemployed doesn’t quickly drive wages down is that, above the level of street sweepers, people are simply not interchangeable. Local knowledge of how the business actually works is critical to “business as usual”. In my experience businesses rely on their current employees to pass that understanding to the new hires, and that depends on the continued goodwill of employees who are mainly the new person’s peers.
    It is much easier to introduce new employees on new projects where there is no history. In a recession there are fewer new projects and little or no fat in “business as usual”. As a result I see employers in my business (software design & maintenance) asking for increasingly specific combinations of skills in order to keep their selection and training costs down. For example, I see government departments in Canberra advertising either for new graduates, who are cheap, or effectively fishing in the pool of their ex-employees.
    For an employer the internet makes it cheap to attempt a perfect match, but if a perfect match isn’t available it doesn’t reduce the cost of evaluating the imperfect matches. For an employee in a recession, her local knowledge may be much more valuable than her general industry knowledge, so she can’t improve her income by changing jobs, and her employer has no incentive to pay above “market rates”. Perhaps the internet has made job search cheaper, but the recession has made the selection criteria much narrower, so that there is no net gain.

  20. I am an anthropologist of media, and I have been spending the past year in the Bay area studying how new technologies has been affecting hiring practices. And some of the claims about how the Internet changes hiring aren’t true for the people I have been studying. The Internet hasn’t provided job-seekers with much more information, it just seems to have provided them with the hopes that they might be able to get the desired information if they can just find the right person to have coffee with them and tell them what jobs might be available or what it is really like to work at a particular company. So they definitely feel like there is more hope that they can get this information, but not there is not that much more evidence that they are actually getting this information. Instead, what the Internet seems to do is generate such an excess of applicants for every job that they often feel like their resume is lost in a black hope of applications.

    At the same time, the people I talk to don’t seem to be holding out for better jobs. They are happy to take any job (that actually pays — they will occasionally get offers to work for sweat equity which is not appealing when you have to pay bills). If people were holding out for better jobs, wouldn’t there be more evidence of multiple offers? I recently compiled 380 stories of how people got jobs, and only 4.5% mentioned multiple job offers. The job search that economists are describing doesn’t seem to match the reality that I have been observing.

  21. I accept the general point that computers should have improved matching, but….
    “And there’s no evidence that this has been offset by an improvement in matching. Rather, lots of people have been forced to accept jobs that make little use of their education and experience, suffering wage losses as a result.”

    You’re assuming there that there are loads of jobs available that REALLY CAN make us of “education and experience”. That could be largely untrue.

    “Why doesn’t competition between unemployed and employed workers work quickly to reduce wages to the point where demand equals supply?” That’s easily answered, in fact it was answered by Keynes nearly a century ago: wages tend to be stick downwards. At least they’re nowhere near as flexible as share prices on the stock exchange.

  22. I think you are right that the internet ought to have made some sort of difference if search is important, and you are right to say there’s more to unemployment than search frictions (and the labour economists that I know who use search models would agree) but I think you might be taking too narrow a view of what search represents. The internet might have made some aspects of job search easier, but there’s more to search that finding a job advertisement and sending your CV into the employer. Look at the economic job market – we have all these whizzy online systems, but job search is still a very onerous difficult process. And employers still find it hard to find the right employees.

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