Much Ado About Nothing: the Labor Mismatch Problem

Is the ongoing weakness in the labor market the result of a large skill-mismatch problem? Many observers think so.  David Altig of the Atlanta Fed, however, says based on the evidence the answer is no:

Despite the fact that we see some evidence consistent with skill mismatch, it is far from clear that this issue is the smoking gun that explains the current anemic state of job growth…we have yet to find much evidence that problems with skill-mismatch are more important postrecession than they were prerecession. We’ll keep looking, but—as our colleagues at the Chicago Fed conclude in their most recent Chicago Fed Letter—so far the facts just don’t support skill gaps as the major source of our current labor market woes.

A far easier explanation that falls out of the data is that there is insufficient aggregate demand.  Let me be clear here. By insufficient aggregate demand I mean a lack of aggregate nominal spending created by an excess demand for retail and institutional money assets (i.e. the safe asset shortage problem).  This is a problem the Fed could solve through better management of expectations.  The Fed has failed miserably here and is therefore indirectly responsible for the labor market weakness.

Recent posts by Mike Konczal and myself provide some of the evidence for the insufficient aggregate demand view. Here are a few highlights from those posts. First, the NFIB’s survey of Small Business Economic Trends has consistently reported the number one problem facing firms is not labor quality, regulation, or taxes.  It is a lack of sales or demand.  If  the labor mismatch problem were as important as some make it out to be, one would expect to see labor quality be a bigger concern for firms.

Moreover, if one plots the NFIB’s data on the lack of demand against the unemployment rate there is a striking relationship that underscores the insufficient aggregate demand view:

Finally, if the skill-match problem were an important part of the story we would expect to see those with the most current skill set to be fairing better than others in the labor market over the past few years. As this figure from Shierholz et al.(2012) show, however, this is not the case:

Occam’s razor tells us that the simplest answer is sometimes the best. That and the lack of conclusive evidence for the skill-mismatch hypothesis indicates that we should probably take seriously the insufficient aggregate demand view.

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