Unemployment and Labor Markets

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The purpose of this project is to develop and to test empirically a model of "wait unemployment" which is designed to explain both the incidence of cyclical unemployment across skill groups and also the extent of cyclical variation in job quality for workers of given skill. The theoretical model provides a microeconomic foundation for the phenomenon of upward and downward mobility of workers over the business cycle first observed by Arthur Okun. The treatment of unemployment in the model closely parallels the treatment of unextracted exhaustible resources in Hotelling's model of natural resource extraction. The model will be tested with panel data from the National Longitudinal Survey. The project will provide new estimates of the extent of cyclical variability in wages and "job quality" for workers either leaving unemployment or else entering the labor force. The theory predicts that it is these new job seekers, rather than the entire workforce, which will experience significant cyclical variation in job opportunities. This project addresses an important critique that has been levelled against models assuming involuntary unemployment. Even in the deepest recessions, substantial numbers of new jobs are constantly being created and filled. Assuming that employers prefer to fill new jobs with the highest quality workers available, highly skilled individuals can easily bump less skilled workers for the job openings which appear in recessions. Simple models with involuntary unemployment imply incorrectly that the incidence of cyclical unemployment will fall entirely on the least skilled members of the labor force. The key insight pursued in this line of research is that a high quality worker who takes a "poor quality" (low paying) job, perhaps in a recession, will suffer long term consequences from this decision. Preliminary work by the investigators under their previous NSF grant demonstrates that this assumption is realistic and the theory yields many testable predictions regarding the behavior of the labor market. This project extends the theory and tests it empirically.