Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Stock Market Enters Early Summer Correction Trend Forecast Time Window - 11th May 21
GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
Cathy Wood Bubble Bursts as ARK Funds CRASH! Enter into a Severe Bear Market - 11th May 21
Apply This Technique to Stop Rushing into Trades - 10th May 21
Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
CHIA Getting Started SSD Crypto Mining by Plotting and Farming on Your Hard Drives Guide - 9th May 21
Yaheetech Mesh Best Cheap Computer /. Gaming Chairs on Amazon Review - 9th May 21
Breaking US Trade Embargo with Cuba - Build 7 Computers in 14 Hours Before Ship Sales Challenge - 9th May 21
Dripcoin Applies New Technology That Provides Faster Order Execution - 9th May 21
Capital Gains Tax Hike News: Was It REALLY to Blame for Sell-off? - 7th May 21
Stock Market Transportation Index Continues To Grind Higher - 7th May 21
SPX Stock Market Correction Arriving or Not? - 7th May 21
How to Invest in an Online Casino? - 7th May 21
Gold & Silver Begin New Advancing Cycle Phase - 6th May 21
Vaccine Economic Boom and Bust - 6th May 21
USDX, Gold Miners: The Lion and the Jackals - 6th May 21
What If You Turn Off Your PC During Windows Update? Stuck on Automatic Repair Nightmare! - 6th May 21
4 Insurance Policies You Should Consider Buying - 6th May 21
Fed Taper Smoke and Mirrors - 5th May 21
Global Economic Recovery 2021 and the Dark Legacies of Smoot-Hawley - 5th May 21
Utility Stocks Continue To Rally – Sending A Warning Signal Yet? - 5th May 21
ROIMAX Trading Platform Review - 5th May 21
Gas and Electricity Price Trends so far in 2021 for the United Kingdom - 5th May 21
Crypto Bubble Mania Free Money GPU Mining With NiceHash Continues... - 4th May 21
Stock Market SPX Short-term Correction - 4th May 21
Gold & Silver Wait Their Turn to Ride the Inflationary Wave - 4th May 21
Gold Can’t Wait to Fall – Even Without USDX’s Help - 4th May 21
Stock Market Investor Psychology: Here are 2 Rare Traits Now on Display - 4th May 21
Sheffield Peoples Referendum May 6th Local Elections 2021 - Vote for Committee Decision's or Dictatorship - 4th May 21
AlphaLive Brings Out Latest Trading App for Android - 4th May 21
India Covid-19 Apocalypse Heralds Catastrophe for Pakistan & Bangladesh, Covid in Italy August 2019! - 3rd May 21
Why Ryzen PBO Overclock is Better than ALL Core Under Volting - 5950x, 5900x, 5800x, 5600x Despite Benchmarks - 3rd May 21
MMT: Medieval Monetary Theory - 3rd May 21
Magical Flowering Budgies Bird of Paradise Indoor Grape Vine Flying Fun in VR 3D 180 UK - 3rd May 21
Last Chance to GET FREE Money Crypto Mining with Your Desktop PC - 2nd May 21
Will Powell Lull Gold Bulls to Sweet Sleep? - 2nd May 21
Stock Market Enough Consolidation Already! - 2nd May 21
Inflation or Deflation? (Not a silly question…) - 2nd May 21
What Are The Requirements For Applying For A Payday Loan Online? - 2nd May 21
How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part1 - 1st May 21
INDIA COVID APOCALYPSE - 1st May 21
Are Technicals Pointing to New Gold Price Rally? - 1st May 21
US Dollar Index: Subtle Changes, Remarkable Outcomes - 1st May 21
Stock Market Correction Time Window - 30th Apr 21
Stock Market "Fastest Jump Since 2007": How Leveraged Investors are Courting "Doom" - 30th Apr 21
Three Reasons Why Waiting for "Cheaper Silver" Doesn't Make Cents - 30th Apr 21
Want To Invest In US Real Estate Market But Don’t Have The Down Payment? - 30th Apr 21
King Zuckerberg Tech Companies to Set up their own Governments! - 29th Apr 21
Silver Price Enters Acceleration Phase - 29th Apr 21
Financial Stocks Sector Appears Ready To Run Higher - 29th Apr 21
Stock Market Leverage Reaches New All-Time Highs As The Excess Phase Rally Continues - 29th Apr 21
Get Ready for the Fourth U.S. Central Bank - 29th Apr 21
Gold Mining Stock: Were Upswings Just an Exhausting Sprint? - 29th Apr 21
AI Tech Stocks Lead the Bull Market Charge - 28th Apr 21
AMD Ryzen Overclocking Guide - 5900x, 5950x, 5600x PPT, TDC, EDC, How to Best Settings Beyond PBO - 28th Apr 21
Stocks Bear Market / Crash Indicator - 28th Apr 21
No Upsetting the Apple Cart in Stocks or Gold - 28th Apr 21
Is The Covaids Insanity Actually Getting Worse? - 28th Apr 21
Dogecoin to the Moon! The Signs are Everywhere, but few will Heed them - 28th Apr 21
SPX Indicators Flashing Stock Market Caution - 28th Apr 21
Gold Prices – Don’t Get Too Excited - 28th Apr 21
6 Challenges Contract Managers Face When Handling Contractual Agreements - 28th Apr 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Nobel Committee in Search of Economists

Economics / Economic Theory Oct 14, 2010 - 10:55 AM GMT

By: Robert_Murphy

Economics

Best Financial Markets Analysis ArticleThis year's Nobel Memorial Prize in Economics goes to Peter Diamond, Dale Mortensen, and Christopher Pissarides, for their work on "search theory," especially as applied to labor markets. In the present article I'll explain the basics of their contribution but then point out the crisis in mainstream economics: even though these economists — especially Diamond — are very smart and productive, they and their colleagues have hardly helped the plight of the unemployed, as we stumble ever deeper into depression.


Search Theory in the Labor Market

According to the official press release,

This year's three Laureates have formulated a theoretical framework for search markets. Peter Diamond has analyzed the foundations of search markets. Dale Mortensen and Christopher Pissarides have expanded the theory and have applied it to the labor market. The Laureates' models help us understand the ways in which unemployment, job vacancies, and wages are affected by regulation and economic policy. This may refer to benefit levels in unemployment insurance or rules in regard to hiring and firing. One conclusion is that more generous unemployment benefits give rise to higher unemployment and longer search times.

Now, many cynical readers will consider this akin to "proving that water runs downhill," as a wag once described mathematical economic models that formalized the obvious. Whether for good or ill, the laureates developed models with all the modern bells and whistles to show this intuitive result. (If you are curious, check out this summary paper; the policy implications of raising unemployment compensation are discussed on the bottom of page 41.)

I am not the person to give a summary of the academic output of these three individuals; Tyler Cowen has done a remarkable job here, here, and here. Instead I'll opt for the more modest goal of conveying the essence of the laureates' award-winning work.

In the most basic supply-and-demand analysis of the labor market, it's a wonder that there should ever be unemployment. In this simple framework, if there are millions of people out of work, then the market wage rate is obviously above the "equilibrium" value — the value at which the supply and demand curves intersect — and full employment should quickly be restored as wages fall.

Of course, in the real world unemployment often does not quickly resolve itself through falling wages. So something is clearly wrong with the simplistic story we tell in introductory econ classes.

"Whether for good or ill, the laureates developed models with all the modern bells and whistles to show this intuitive result."

Economists have come up with different explanations. Austrians, for example, might point to government or labor-union (supported by government) intervention in the labor markets. Other economists might declare that "wages are sticky" because of issues of morale.

What the recent laureates did was to break away from the view that there is a transparent labor market with "the" prevailing wage and one homogeneous job category. In the real world, an unemployed worker doesn't know all of the potential employment opportunities that exist, and a firm with a job vacancy doesn't know all of the potential candidates. The workers and firms must search for each other, and this search is itself costly and time-consuming.

Once we take into account the uncertainty of the job-search process, it is easy to see why unemployed workers don't always take the first job offer they get. In their formal models, Mortensen and Pissarides would assume that a worker faces a probability distribution of job offers with various wage rates.

To consider a watered-down illustration, suppose that Joe is unemployed but looking for work. With all of the hassle of looking for openings and then attending multiple interviews, Joe figures he will receive a serious job offer once every three months. When he does, he furthermore estimates that there is a 50 percent chance that he will be offered a salary of $50,000, a 40 percent chance that he will be offered a salary of $60,000, and a 10 percent chance that he will be offered a salary of $70,000. At the start of his job search, Joe checks his bank balance and sees that he has enough savings to last him six months on an austerity budget.

To do things formally, we would have to next spell out a "utility function" for Joe, complete with a discount rate on "future utils," in order to solve the constrained optimization problem. But with our simple example, we can see that it would be plausible if Joe adopted the following strategy or "stopping rules": First, if Joe ever gets an offer of $70,000, he should obviously take the job on the spot. That's the best offer he thinks is possible.

Second, if Joe receives an initial offer of $50,000, he should reject it. He still has a 50 percent chance of making more than that by holding out for another three months and burning the rest of his savings. However, regardless of the salary, Joe has to accept the second job offer, because at that time he will have nothing left in the bank.

Third, if Joe initially gets an offer of $60,000, then he should accept it. It's true, at that point he would still have three months' worth of savings and could afford to go through another round of interviewing. But Joe knows he would have to accept the second offer, regardless of what it was, and there is only a 10 percent chance that it would be better. In the meantime, Joe could be earning a salary of $60,000 for three months, rather than drawing down his savings even more. (This decision is even more compelling if we assume that Joe forfeits his initial offer if he doesn't quickly accept it, meaning that there is a 50 percent chance Joe will have to take a $50,000 job.)

"It's not as if the laureates' work has been obscure, or that it is brand new, and thus is a magic bullet that can help mainstream economists advise governments on how to get out of this rut."

Our simple story gives the intuition behind the formal models so esteemed by the Royal Swedish Academy. Once we view the labor market as a problem of searching and matching, it's obvious that at any given time — even in a normal, healthy economy — there will be a large number of unemployed people.

This "natural rate of unemployment" can certainly be influenced by government policy, however. Most obvious, if Joe receives monthly unemployment checks from the government, then he will be more likely to hold out for a better-paying job. Depending on the numbers, perhaps Joe would not accept a $60,000 job offer right away. But every other worker is thinking the same thing, and so (on average) workers take more time in between jobs, meaning that the average unemployment rate is higher.

The Crisis in Mainstream Economics

Obviously the academy chose these recipients because of the current crisis — we need to honor those economists who have helped us understand institutional unemployment! But something is very wrong here. It's not as if the laureates' work has been obscure, or that it is brand new, and thus is a magic bullet that can help mainstream economists advise governments on how to get out of this rut.

On the contrary, Diamond's foundational work is decades old, and, according to Tyler Cowen, the "seminal paper" for which the Nobel was given was written in 1994. Whether you want to claim the Nobel is a pat on the back for Keynesianism (as Krugman did), or to claim that it is a kick in the bottom for old-school Keynesianism (as Cowen did), there's no getting around the fact that these basic insights are at least 15 years old.

Now, it would be one thing if the problem of long-term unemployment had been a tough nut to crack lo these many decades, but finally mainstream economists were beginning to get a handle on it. Then, it would certainly be appropriate to give the Nobel to those researchers who had paved the way, if not for the solution then at least for the path to a solution. But is that really what's happened in economic science?

Conclusion

There is a crisis in mainstream economics. Simply put, the economists have utterly failed in their promises to policymakers and the public. The work of Diamond, Mortensen, and Pissarides may not be directly to blame, but this year's award is just one more example of how out of touch the economics profession has become. To award economists for their contributions to understanding unemployment — just as it is becoming painfully obvious that the leaders of the field do not understand unemployment — is as unseemly as giving someone a Nobel Peace Prize just as he accelerates foreign military conquests.

Robert Murphy, an adjunct scholar of the Mises Institute and a faculty member of the Mises University, runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism, the Study Guide to Man, Economy, and State with Power and Market, the Human Action Study Guide, and The Politically Incorrect Guide to the Great Depression and the New Deal. Send him mail. See Robert P. Murphy's article archives. Comment on the blog.

© 2010 Copyright Ludwig von Mises - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in