Matching Theory - why unemployment levels remain high even when job offers are plenty

"According to a classical view of the market, buyers and sellers find one another immediately, without cost, and have perfect information about the prices of all goods and services... But this is not what happens in the real world," reads a statement about the work of Peter Diamond, Dale Mortensen and Christopher Pissarides, who have won the 2010 Nobel Memorial Prize in Economic Sciences.

The area of economics known as "search theory" is the study of people's strategies when choosing from a series of potential opportunities of random quality, when delaying choice is costly. These economic models attempt to calculate the cost of postponing a choice against the cost of going out and continuing to search.

The reason this is important is because of unemployment.

In the aftermath of any major economic disaster governments and central banks attempt to "prime the pumps"; they release large amounts of cash into the economy and lower interest rates in order to lower the cost of hiring and increase consumption.  When it works, companies borrow to hire on the strength of increasing consumer expenditure.

Except that there is also jobless growth.  Sometimes economies start to turn around, employers offer jobs, but unemployment remains stubbornly high.

Search theory would have it that a person looking for a job should accept any offer within a particular reservation wage zone; a measure of an upper and lower limit acceptable to them.  In practice this doesn't happen.

What Diamond, Mortensen and Pissarides identified is that there can be friction in this search process which leads to an extended period of matching.

For starters, the jobs may not be available anywhere near where the jobless live.  A person unencumbered by responsibility or debt may choose to move immediately in search of those jobs, but only if they know about them. 

A person with a big mortgage on a house that is worth less than the debt on it may feel that it is better to stay and find a job nearby.  Selling the house would leave the person without an asset but with painful debts.

In other words, while searching for a job has costs, so does selecting one.  If the costs of matching your needs to a new opportunity are too great you might not take a job that pays what you want even when it's offered. 

Counter-intuitively, a person may voluntarily remain unemployed for fear of the costs involved in taking on a new job.

Identifying the problem means that we can try and fix it.  Governments could offer financial support to people whose "under water" mortgages prevent them from selling and moving.

Economists have now looked for other costs which can create friction in the search process.  Frictions can be subtle, such as women not working since the cost of child-care leaves a family worse-off than if she weren't working.  Others include unemployment benefits which are higher than potential wages, the costs of gaining or maintaining skills, or simply high taxes on incomes.

These frictions may not only affect job seekers.  Employers can also experience friction.  High regulatory costs of firing a poor employment choice may lead to lengthy interview processes.  Employers will delay making a choice, even on a crucial position, in order to ensure that the candidate is "perfect".

Trying to support increased employment is then a matter not just of creating economic stimulus but also of identifying these frictions and removing or reducing them.

Managing an economy is a little like taking up running.  It is relatively straightforward to achieve a base level of fitness but, once you start racing, you need to concentrate more on technique, equipment and diet.

Governments wishing to reduce long-term unemployment must have the patience and honesty to tackle structural problems that increase friction.  Like winning marathons, full employment takes application, guts and determination.