Many competing microeconomic explanations of unemployment that focus on why individuals do not find work tend to neglect the macroeconomic implications of high unemployment when many remain unemployed for extended periods. In Discussion Paper No. 883, Programme Director Dennis Snower argues that persistent unemployment is inherently puzzling since workers who are tired of seeking work in free markets, where wages are free to respond to labour market conditions, should need only to reduce their acceptance wages. He reviews and assesses theories based on: market clearing (the natural rate, intertemporal substitution, the real business cycle), imperfect information (search, implicit contracts, the efficiency wage), labour market institutions (trade unions, supply shocks caused by automation and trade with real wage rigidity), deficient demand and labour turnover costs.

Snower argues that these theories provide only partial explanations of people's inability to find work and that their main achievement is to clarify what we do not understand. For example, Keynesian models that performed well in predicting unemployment during the 1950s and 1960s have failed to account for divergence of levels of activity in labour and product markets since then; theories ascribing a major role to wage-price sluggishness bear little relation to the facts. Efficiency wage theories, in which firms' imperfect information about their workers' productivities may generate unemployment, provide no account of its variation over time. Insider-outsider theories, in which labour turnover costs create market power, do not adequately relate the power of incumbent workers to the business cycle. Search theory shows how imperfect information allows unemployment and vacancies to coexist, but its predictions are not observationally distinct from those of other, simpler theories. Finally, shocks to oil prices, technology and trade set in motion chain reactions with longer-term implications for unemployment, but the underlying dynamics of this process remain largely unexplored.

Why People Don't Find Work
Dennis J Snower

Discussion Paper No. 883, December 1993 (HR)