Sunday, October 17, 2010

A Prize for the Times

Last week, a trio of academics -- Peter Diamond (MIT), Dale Mortensen (Northwestern) and Christopher Pissarides (London School of Economics) -- were awarded the 2010 Nobel Prize in Economics for their groundbreaking analysis of markets in a way that challenged people to think beyond the traditional supply/demand balance equation.

"The laureates' models help us understand the ways in which unemployment, job vacancies and wages are affected by regulation and economic policy," said the award citation from the Royal Swedish Academy of Sciences.

The researchers set out years ago to try to explain the difficulties buyers and sellers often face in finding each other in the marketplace -- and in particular, how that applies in the job market, where the buyers and sellers are employers and workers. Their conclusion was that laws of supply and demand are indeed the prevailing forces, but that there are limits to their ability to explain all economic conditions.

The reason for this is that there are certain mitigating factors -- what they refer to as "search frictions" -- that intervene in the marketplace and create structural impediments to the supply/demand equation.  This groundbreaking economic theory has since been applied to a host of other topics, from the housing market to the search for a spouse.

(As an aside, in a perfect metaphor for the stupidity of the partisan politics that gridlock our legislative process, Prof. Diamond has been nominated by President Obama to the Federal Reserve Board -- but his confirmation has been held up by Senate Republicans who are expressing reservations about his qualifications.  No word yet as to how many Nobel Prizes sit on the bookshelves of Senate Republicans.)

But the most compelling potential application of the three men's work has to do with the economic times in which we find ourselves right now.  As 2010 has progressed, we've seen a steady flow of encouraging economic data, ranging from improved corporate earnings and appreciation of stock prices to positive signs in the housing sector and consumer spending.  However, the stubbornly high unemployment rate appears to have become stuck in the mid-9% range -- and with this prolonged unemployment problem you have the framework for a massive mid-term voter rejection of the Obama Administration, through the lenses of dozens of Congressional races nationwide.

So, this year's Nobel Prize for Economics was handed out to researchers whose work lies at the center of a hotly contested debate right now over the following question: How much of today's high unemployment is the result of structural changes in the labor market and how much is merely the result of a weak economy?

There is no magic answer to this question, of course, and perhaps not surprisingly the variance in opinions that one hears from academics and economists can be consistently pegged to the individual political perspectives of the person being asked.  No matter where one stands, however, there is no argument that one of the quirks of today's high unemployment in the U.S. is that it has persisted despite an increase in the number of job openings.  Last week, in fact, a new report showed that job openings rose again in August and private sector employers advertised the most number of available jobs since November 2008.

So if job openings are rising and private sector employers are increasingly advertising for help wanted, why do we have an unemployment rate that most economists agree is likely to hit the dreaded 10% level by early next year?  The research by the Nobel laureates suggests that high unemployment can be the result of friction that keeps employers and workers apart. That friction can be tough regulatory rules on firing, a mismatch between the kinds of skills employers need and the kinds of skills possessed by the unemployed, or even -- my personal favorite -- the realization by employers that today's extraordinary technological efficiencies allows them to be just as productive with fewer workers on the payroll.

The point is that it may be too simplistic to view these things from the easy perch of supply and demand, where we could pretty much be sure that as soon as economic conditions improved for employers, they would hire aggressively and the unemployment rate would drop.  In a sign of the times, this Nobel Prize went to a few independent thinkers who challenge us to face the possibility that it's no longer enough to just improve business conditions for employers -- we may need to also focus on creating a workforce that can overcome frictions in the marketplace in order to land those open jobs.

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