U.S. Unemployment: Is Labor Mismatch Inflationary ?

by: Evariste Lefeuvre


The Beveridge Curve is less known than the Phillips curve.

It illustrates the dysfunction of the labor market and suggests that the U.S. economy is suffering from a significant labor mismatch.

Even if the time spent to fill job openings is growing, it does not mean that it will spur inflationary pressures anytime soon.

Less famous than the Phillips curve, which relates unemployment and inflation, the Beveridge curve crosses vacant jobs with the unemployment rate.

Its lesser success is due to the nature of the conclusions that can be drawn from it. While the Phillips curve, at least in its original form, served as a pillar of cyclical policies in the 1960-70s (you could reduce unemployment by accepting a higher inflation rate), the Beveridge curve reports the malfunctioning of the labor marking - something that which can be resolved only by structural policies.

In particular, the Beveridge curve gives an overview of problems of matching within the labor market (the difference between the nature of the jobs and skills available, otherwise known as the labor mismatch). This mismatch can be temporary or permanent-temporary if it requires reallocation of resources between sectors and geographical areas; structural if they are caused by a lack of qualification, education and training.

Today there is a major debate on the nature of US unemployment. Of course, it has declined significantly in recent years, but this has largely been due to the decline in the participation rate (exit from the labor market of a large portion of the working age population). Also, and much more blatant, has been the issue of companies unable to find qualified individuals. The time required to fill a vacancy is the highest since 2001: 25 days. Small businesses cannot fill all their positions, and more than 12% believe that the quality of work is the biggest problem (vs. 4% who complain about the cost).

According to a recent Brookings study STEM jobs (those in science, technology, engineering, and mathematics) take twice as long to fill as other jobs. No wonder the latest Beige Book from the Federal Reserve reported that wage pressures, which are generally very low in the broad economy, are concentrated in these occupations.

The chart below, from a 2011 speech by Fed President Janet Yellen presents the Beveridge curve since 1970. We can see that there are a few salient features in this chart.

1. 1. Over the decades, the curve has undergone translations to the northeast or southwest quadrants. These parallel movements generally reflect the evolutions of institutions in the labor market, and when the movements have been downward, a better match between labor supply and demand.

2. The curve has seen temporary movements during recessions, for example. As these usually entail a reallocation of resources between sectors and geographical areas, it is not surprising to see a concurrent rise in the unemployment rate and the job vacancy rate (illustrated by the curves in the far right corner).

This is what Yellen has warned about for the past few years, arguing that the move to the northeast of the black curve is mainly due to a lack of aggregate demand, and more importantly, that these temporary changes will eventually correct.

However, the curve has been slow to return to its previous level. As seen below, despite the drop in the unemployment rate, the curve is much higher than the level that prevailed prior to the crisis. The job vacancy rate today would have coincided with an unemployment rate close to 4% in the previous cycle.

It is therefore necessary to face the facts and admit that the U.S. labor market does not work well. A NBER study suggests that the difference between qualification requirements and offers explains a little less than a third of the increase in the unemployment rate observed during the Great Recession. For the authors, neither geography nor lower internal mobility is in question.

The reasons are multiple, and explained in part by the structural reorganization of the US economy (the mining sector rose from 1% to 2.6% of GDP between 2002 and 2012). The recovery in the housing sector, where relative wages are generally higher, has been disappointing. However, it has not generated a major wave of re-classifications as it is difficult to convert a builder into a medical assistant overnight. Also, twenty years of the decomposition of education explain the growing difficulties of companies to recruit managers and engineers. The most recent PISA report from the OECD states that "the US performed below average in mathematics in 2012 and is ranked 27th" among the OECD countries, and that "performance in reading and science are both close to the OECD average," meaning the U.S. ranks 17th in reading and 20th in science. There really is a problem of specialization and adequate training.

The measure used (time spent to fill a vacancy) may be biased though. If companies are taking more than 25 days on average to fill a position, is this because of a lack of suitable candidates? Or on the contrary, due to excessive caution, a refusal to hire the long-term unemployed (the share of long-term unemployed increased from 20% in 2008 to 45% in 2013)? This is very likely since, according to Kroft and al, there has not been any significant "compositional shift towards group with traditionally longer unemployment duration."

Moreover, the relationship between the duration of unemployment and the rate of re-employment has increased. Several studies show that "callbacks from employers to set up an interview decline with the current non-employment duration on a job applicant's resume." Also, it is not impossible that the rate of long-term unemployment is higher than it would have been if the duration of unemployment compensation/insurance had not increased during the recession (people stayed in the workforce as they continued to report themselves as unemployed).

A large movement of the Beveridge curve to the northeast can be explained by higher rates of long-term unemployment, linked to the lack of skills, but also to the impact of the massive demand shock that followed the subprime crisis. Failure for the curve to return to the south east is explained by a strengthening of the relationship between duration of unemployment and low "employability": a perceived loss of human capital that may not be justified.

Add to this the fact that a rise in time to fill job openings can be a signal of a better growth outlook. As shown below, the more the economy is growing, the more time it takes to fill a position. "Tensions" in the labor market would therefore, in this context, be only a reflection of the strength of economic recovery. As can be seen below, the link between recruitment difficulties and ISM (indicator of economic activity) is no different today than it was before the crisis.

Lastly, the chart below shows that such a level of the perception of hiring difficulty has historically been consistent with higher wage growth. Several studies report that reduced mobility and activity of job seekers in recent years has been due to the weak response of the wage recovery. Yet, a study from the Gallup Institute shows that 35% of Americans now think it is a good time to find a job vs. 20% in who think the environment will be better in 2 years. Coupled with an improving outlook, it could bring back discouraged workers to the labor market.

Bottom line: the consequences of such a development are numerous, but distinguish two key points.

In the medium term, a change in policy is even more necessary now that technical progress may polarize more jobs (more engineers and individuals capable of managing complex situations, and more service activities that require adaptation and proximity).

In the short term, evolution could be disastrous for unskilled workers, because if the central bank had to fear a resurgence in wage inflation, we could once again see the weakest suffering from an excess of Fed caution. The Fed may try to fight against bubbles by tightening regulations, and while this may not be sufficient, the biggest mistake would be if monetary policy tightened before the rise in wages was really widespread.

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