Unemployment-Vacancy Paradox

Is it possible that there could be large hordes of people unemployed in an economy while vacancies could mount at a staggering pace? Well that is not uncommon and India is not very far away from this paradigm.

Labor markets remain sticky on wages and no matter how much it may be commoditized, there is far too much of friction that makes transmission of wage signals difficult on one hand and the matching of unemployment  with vacancy is part of what Economists call the Beveridge curve, which has many nuances we ignore to our own peril. The curve plots vacancies as a percentage of the total labor force on y axis and unemployment on the x-axis. The curve shows that beyond a threshold vacancy rate the unemployment number could rise to any level and the vacancies could still remain unfulfilled.

This curve and the Phillips curve that plots rates of unemployment with the percentage change in wages or inflation and the relationship is inverse, seem to be at odds and this is compounded by the crucial question of matching skills with vacancies on offer and this must finally clear the market and this is part of the Search Theory that got the Nobel Prize in Economics in 2010.

So India could have an unemployment problem, not just because we have less jobs getting created, it could well be that there are so many jobs waiting to be filled but the right match isn't happening because of other frictions in the market. Minimum wage sets the floor and when it is raised the demand response counteracts the supply response as more labor supply tries to clear the market. In specific markets with monospony, the wage line could be fixed at lower the productivity norm. Or when unemployment happens due to lack of demand in a sector, the workers with skills cannot get into another sector (financial markets or auto markets are best examples).

Recently one of our partners commented that there is so much of unemployment we hear but when we try to mobilize people for Greenfield construction sites, we run out of people. This is precisely the problem we are talking about.

Three Nobel Prize winners of 2010, Peter Diamond, Christopher A. Pissarides & Dale T. Mortensen helped us to get close to the puzzle in labor markets and the puzzle is primarily because labor markets differ from the other markets in more ways than one. First of all labor supply and demand is not frictionless like in any commodity market, if demand for labor shifts, supply does not shift instantaneously; there is a time dimension which is connected to search and matching problems we will discuss.

You are searching for an item you want to buy from a store, you look at the available options and the prices are displayed, so you can exercise your choice. If you are not satisfied with a store you can search another store, the marginal cost of search can be lowered if you select a large store like Walmart where your search costs could be lowered. Sellers play a role to reduce your search cost by making their products available in one place, Hotelling the Stanford Mathematician solved this puzzle and he provided the mathematical solution why fish sellers stay in one place or why all brands of cosmetics are displayed in one place instead of in many different parts of the Super market. It is simply to reduce search cost.

Labor markets have a problem, the prices for the skills are not displayed like in super markets. Some companies do not even publicly announce what wages are on offer and it remains up to the individual to negotiate. The more the skills move up the more difficult this becomes and there is an information asymmetry associated with this as well.

The biggest challenge is the time dimension. The person losing a job with specific skill sets would not be able to quickly readjust to the new paradigm when the likelihood of getting jobs with his existing skill sets has a low probability as the industry sector itself could be going through the problems of job demand. So an investment banker with specific skill sets or an auto worker could face an issue and would not quickly like to switch to a job in the hospitality sector which could remain unaffected.

How much would be the acceptable wage for a job loser is also not a straight thing, it would need to go through iterations of sorts to settle at a score when job matching can happen. This could take time and time as an important dimension actually adds to the puzzle.

The frictions associated with labor markets also has government policies as factors, like policies could be rigid in some states on compliances while loose in others. Minimum wage itself could be set at different prices, policies that incentivize search could be different in different states. Government jobs could have quotas protecting one class over the other, skills could be a very different matter.

All of these are reasons why many government vacancies never get filled up.

If we focus on the search costs and prepare policies that reduce search costs, we would go a long way. Holding recruitment Melas or Fairs where buyers and sellers of labor can come together are very useful tips.

But all this would be dwarfed by the effort needed on skill development. As India moves up the value chain, skills are the biggest items that are in short supply. There is not an unemployment problem in India as much there is a skill gap issue.

The jobs that are getting created today and the skill inventory has a matching issue which is structural in nature. The problem is further compounded with the direction of future job creation.

Are we doing enough on bridging this gap is the bigger question.