Tuesday, October 12, 2010

The 2010 Riksbank Prize in Economics Sciences Goes To…

Peter A. Diamond of MIT, Dale T. Mortensen of NWU, and Christopher A. Pissarides of LSE “for their analysis of markets with search frictions."

From the press release:

Why are so many people unemployed at the same time that there are a large number of job openings? How can economic policy affect unemployment? This year's Laureates have developed a theory which can be used to answer these questions. This theory is also applicable to markets other than the labor market.

On many markets, buyers and sellers do not always make contact with one another immediately. This concerns, for example, employers who are looking for employees and workers who are trying to find jobs. Since the search process requires time and resources, it creates frictions in the market. On such search markets, the demands of some buyers will not be met, while some sellers cannot sell as much as they would wish. Simultaneously, there are both job vacancies and unemployment on the labor market.

I’ve been thinking along the lines that with the NEM/ETP proposals, there will be a rise in structural unemployment due to a skills and knowledge mismatch between what’s required for the new economy, and what the existing labour force has to offer. I’ve also been concerned over what could be done about Malaysia’s persistent income inequality problem.

One of the solutions that has been shown to work for those limited objective is higher benefits for the low income group as well as for the unemployed. Now I have to read up on the research mentioned – and it looks like it’s back to the drawing board. The work of this year’s Nobel Laureates in Economics* shows that higher benefits basically entrenches structural unemployment.

So that idea’s out the window. Oh well.

*The official name of the Economics prize is The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel


  1. It is always higher productivity that raises wages and increases returns to capital owners. When labour is productive in any sector that is open to competition, there is no need to worry about temporary labour adjustments because eventually the structurally unemployed will eventually find work, albeit possibly in lower value jobs.

    Malaysia's labouur force has to structure up the value chain and not, like the US, be devalued due to outsourcing and distortions caused by excessive debt cycles.

    Once capital is made more productive by labour, then the high quality labour will migrate to that sector.

    Worrying about the short term pains often subverts the long-term benefits. And that is often the problem with Msian policy makers who have grand visions but a timid execution record.

  2. Nehemiah, I mostly agree, but there is a time-shift problem here. I don't believe there's any mechanism through which structurally unemployed labour will eventually find work in the absence of policy intervention (I'm thinking here specifically of non-plantation agriculture, but it applies generally as well). Nor is it a given that productivity improvements necessarily lead to higher returns to labour.

    In the tradables sector, wages are set in the global labour market, not the domestic labour market. Productivity improvements in this instance would lead to lower or stagnant real returns to labour, not higher - the excess returns will be entirely appropriated by owners of capital. I know that's counterintuitive, but it does explain Malaysia's experience over the past 10-20 years (ref: Balassa-Samuelson Hypothesis).

    You mention that our labour has to "structure up" - what if fundamentally it can't? Or at least, not the older segments of the present generation workforce?

    I think it will take half a generation before the workforce has the capabilities required, mainly through the influx of new labour entrants rather than a reskilling of the existing work force. Reskilling/retraining at older ages has generally been proven to be ineffective (and I'm not talking about the local experience either).

    But that still leaves the problem of those left behind.

    Let me give an example: coastal fishermen. It's a dying industry, and their skills just don't translate to any "modern" commercial entrerprise. No amount of reskilling will allow them to find alternative work. Luckily (or sadly), their average age is well north of 50, which means we don't have to worry too much about supporting them much further, as the government has been doing (rather inefficiently I might add).

    I'm not in disagreement with your main point - we need to upgrade the workforce and open up competition, no question. But I don't think the welfare costs will be low, or confined to the short term.

  3. BTW, you might want to read this: