The Market for Lemons
By Steve Hine
As the Returning to Work article (from this issue) clearly shows, the dramatic increase in the number and share of long-term unemployed is a distinctive feature of the recent recession, and it will have lingering effects far into the future. Long-term unemployment — typically defined as being out of work for six months or more — imposes costs on people that go well beyond lost wages. Future earnings are lower, health is negatively impacted, and even relationships and self-esteem are damaged.1 These significant costs suggest the need to identify and ameliorate the causes of long-term unemployment and the factors that reduce the odds of re-employment the longer an individual is unemployed.
A number of reasons have been posited for this inverse relationship between unemployment duration and re-employment probability. These reasons might include the atrophying of skills that occurs with being out of a job for so long, or the likelihood that those with highly marketable skills will find employment more quickly than those with less marketable skills. Worker retraining programs are a ready response to this problem. Another reason might be that long spells of job hunting tend to affect people over time. Job seekers become discouraged, and this discouragement, in turn, can negatively impact candidates’ presentations of themselves in job interviews. The popularity of support groups and job clubs is evidence that this is a real phenomenon.
Yet another reason the long-term unemployed face increasing difficulties in their job searches is that employers have increasingly discriminated against them by requiring current or very recent employment as a precondition for being considered for a job.2 The practice has been widespread enough that the District of Columbia and 17 states, including Minnesota, had bills introduced during their 2012 sessions to outlaw it, although only New Jersey, Oregon and the District of Columbia have enacted such legislation.
Some of this “discrimination” may well be a cost-effective (a.k.a.. cheap) response to the previously identified reasons that a longer-term unemployed person may indeed be an unattractive candidate. But often the practice is seen as a response to the perception that some of the long-term unemployed are simply deadbeats who haven’t tried hard enough to find work. But to engage in practices that exclude the millions of long-term unemployed who would be fully qualified and capable candidates from consideration is costly to those individuals affected and to the economy that now loses out on their productivity.
In 2001, George Akerlof won the Nobel Prize in economics in large part for an article titled “The Market for Lemons: Quality Uncertainty and the Market Mechanism.”3 In this article he argues that in the market for used cars, the inability of buyers to distinguish quality cars from defective “lemons” results in a lower price being offered for all used cars and that many transactions that would have occurred in the presence of better information do not occur. Akerlof’s analysis and its impact on the used-car market might also be applied to the labor market and, in particular, to the pool of long-term unemployed.
If there is some chance, either real or simply perceived, that a hire from the pool of long-term unemployed could turn out to be a lemon (although perhaps couch potato would be a more apt vegetal metaphor in this context), then employers will be less willing to use the long-term unemployed as a source of candidates rather than the short-term unemployed or currently employed. The end result is that hires that would be mutually advantageous to the employer and job seeker do not occur and society as a whole suffers an efficiency loss.
One mechanism through which we ameliorate these inefficiencies in the used-car business is the used-car warranty. Although new hires may not come with a warranty, job interviews, reference checks, probationary periods and other practices common in human resource management are meant to serve as similar devices. Job seekers are also instructed to demonstrate initiative through volunteer work or other activities during their unemployment spells in order to demonstrate their “high quality.” Part of the solution should also be the recognition that “lemons” truly make up a small if not insignificant share of the nearly 5 million long-term unemployed. As I have found as a frequent used-car shopper, there are lots of “good buys” out there just waiting to prove themselves.
3Quarterly Journal of Economics, Vol. 84, No. 3, August 1970, Oxford University Press.