On the Incidence of Unemployment

Abstract

An enduring characteristic of historical labour statistics is that the incidence of unemployment is consistently and substantially lower among skilled craftsmen than among simple labourers.1 Theories of this occupational differential in unemployment rates have focused on two aspects of the relationship between labour inputs-comparative variability and mutual substitutability. Oi [12], for instance, observes that, relative to the wage rate, fixed costs of hiring and training are much higher for skilled than for unskilled workers. The amortization of fixed expense forms a buffer between the wage rate and the value of labour's marginal product, and to some extent cushions the demand for skilled employees against abrupt shifts due to short-run fluctuations in the output market. Common labour largely lacks this protective shield and, consequently, bears the brunt of increases in the unemployment rate. Reder [13], [15], on the other hand, stresses the substitutability of skilled for unskilled workers. During recessions firms react to falling demand by tightening hiring standards and thus displacing some employees from each labour grade down the occupational skill ladder. This course of action would not be sensible without two crucial postulates: (i) the skilled rate is fully flexible, but variations in the unskilled labour rate are constrained by an exogenous floor, the social minimum rate [15, 312-313]; and (ii) craftsmen displaced down the skill ladder cannot or will not find a job commensurate with their skills in some other, non-depressed, sector of the economy.2 Clearly, then, if such theories of the labour market are to account for pure, excesssupply unemployment (e.g. layoffs), they must be supplemented by a strong postulate such as an exogenous stickiness in the wage rate. It is the purpose of this paper to demonstrate that occupational unemployment differentials can be explained in a short-run framework on considerably weaker assumptions. A market with two labour skill grades is characterized in Section 2 by a state-preference model which permits involuntary unemployment to occur at equilibrium. The crucial concept here is that labour services are not exchanged for (and job offers are not evaluated by) wages alone, but for implicit labour contracts which permit the market to form estimates of contingent unemployment probabilities. Rational substitution of skilled for unskilled workers is examined in Section 3 in the context of effective production. Sections 4 and 5 investigate the optimality of full-employment contracts and spell out the main result: at equilibrium, the expected rate of involuntary unemployment for common labour never falls short of, and usually exceeds, that for skilled labour. Consequently, layoffs by seniority may well represent rational behaviour on the part of the market rather than acquiescence to an arcane rule. The cyclical implications of these findings are examined in Section 6 and suggested extensions are laid out in the concluding section.