Wednesday, October 19, 2011

Labor market matching problems

Conventional public policy on employment generation is limited to the creation of new jobs and training to equip job seekers with requisite skills to compete in the job market. Since the former is directly related to the larger issue of economic growth, the focus of government driven employment generation programs have been largely confined to the later.

However, this approach, while a necessary requirement in any employment generation policy, may be a limited view of the dynamics of labor markets. I can think of atleast two dimensions of labor market inefficiency that keeps employment market at a sub-optimal equilibrium.

1. Matching unemployed labor to employers - At any time there are unemployed people looking for jobs and buyers of this labor searching for sellers. The problem is how to match them. This is a big challenge with un-skilled and semi-skilled service sector jobs. How do we match demand for specific jobs at a specific location and on specific terms, with sellers who meet all these requirements?

Such first level of matching immediately adds people to the workforce and reduces job-search inefficiencies. Businesses benefit by way of lower search costs for employing required labor (firms incur expenditures varying from 1-3 months salary as the cost of locating the right labor pool). People stay out of workforce for longer than necessary. Can public policy lower this inefficiency?

2. Optimal matching of under-employed labor - This involves matching employed people with jobs appropriate for their skill and capability level. In other words, it enables efficient matching of labor supply and demand.

Consider the case of Ramu, working with a small, single employee mom-and-pop clothes retailer in a city. After two years in the job, Ramu acquires enough skills to assume more demanding responsibilities. He can easily fit into the role of a lower manager in a shopping mall. His place can in turn be taken by a semi-skilled or even unskilled new addition to workforce, Ravi, who recently migrated from the neighbouring district in search of jobs. Everyone benefits - Ramu benefits by way of higher wages, Ravi gets employment, mom-and-pop retailer gets employee at lower cost, and the mall gets an employee with skills and experience. Most importantly, the economy benefits by way of productivity enhancing efficient matching of two people with varying skills with jobs that are most appropriate for them.

When several millions of such matching takes place, the efficiency gains are massive. It translates into the mom-and-pop shops expanding and hiring more labor, the mall increasing its sales, consumption by the new additions to the workforce adding to aggregate demand, and so on. In other words, the removal of such inefficiencies sets the stage for a virtuous circle of economic growth and job creation. How can public policy enable the removal of these inefficiencies and facilitate efficient matching of labor supply and demand?

In both these cases, the fundamental issue is a matching problem - how do we match unemployed or under-employed workers with their potential employers? Left to itself, for various reasons, the markets cannot enable efficient matching, especially in developing economies. Therefore, what role can governments play in facilitating such matching?

I had blogged earlier about the possibility of governments facilitating this by establishing and adding value to a dynamic meta-labor supply database. This would serve as a database for individual employers or placement agencies to locate job seekers who meet their requirements, thereby benefiting both sides.

I am strongly inclined towards the view that public policy has an important role to play in facilitating this matching process. The debate should be about how to achieve it without creating any major labor market incentive distortions.

1 comment:

Sai Prasad said...

Markets are, of course, dynamic places which keep shifting their equilibrium. In this article the assumption is that an imbalance exists and which when corrected, would remain there for some time.

We are also trying to squeeze out the last drop from the market, assuming that the system is not in a position to self correct.

I am not sure if that is the case. I feel that the situation as it stands today is the optimal one. Firms might be preferring sub-optimal employees for a variety of reasons (cost, Loyalty, 'He cant go elsewhere', etc).