Using Search Theory to Better Understand Long Term Unemployment

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Peter Diamond won a Nobel Prize for his work in search theory. His work applies well to our current problem of long-term unemployment. Some economists have argued that long term- unemployment is due to mismatches between the skills that employers are seeking and the skills that are available among the unemployed. They point to the large loss of jobs in the construction industry and suggest that it is hard to find a job for a carpenter, for example, in the computer industry. One of the consequences of this analysis is that the unemployment rate is not a function of the business cycle; therefore, it does not make sense for government to take actions to stimulate aggregate demand. Diamonds, work in search theory suggests that both employers and workers behave differently in a recession that is triggered by a financial crisis. The degree of uncertainty, from both perspectives, differs from what we might find in a normal economy or during a mild recession. He takes issue with the idea that long-term unemployment is due to structural factors in the labor market. There is more friction in the search function and that may explain some of what we see. In any case, there is little empirical support for explaining away long-term unemployment away by calling it structural unemployment. It makes better sense, given the uncertainty, to make efforts to increase aggregate demand.