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Pissarides: Reduce cost of labor mobility to promote employment

Sir Christopher A. Pissarides is Professor of Economics at the London School of Economics. 

In 2010, he was awarded the Nobel Prize in Economics for his contribution to the theory of search frictions and macro-economics.

 He is scheduled to attend the China Development Forum 2017.

Editor’s note: Since the financial crisis in 2008, the developed economies have beenfaced with problems in employment structure at different levels. Jobs in manufacturing and management, which used to boost the income of the middle class, have been mostly contracted in the European Union and the United States. Low-end services and high-tech industries have provided a large proportion of new jobs, gaps between rich and poor have widened, and the traditional middle class has become more dissatisfied. So, how to interpret and respond to the structural changes in the job and labor force market? The China Development Forum 2017, due to take place in March, will focus on topics such as global inequality and middle-class anxiety. Sir Christopher A.

Pissarides, a Noble Prize laureate, is going to attend  China Development Forum 2017. He was born in Cyprus to a Greek Orthodox family, and is now Professor of Economics at the London School of Economics. In 2010, he was awarded the Nobel Prize in economics for his contribution to the theory of search frictions and macroeconomics.


I. Pissarides’ economic observations

1. Industry transfer of labor force

Unlike traditional competitive market theories, the search and matching theory thinks that from the perspective of labor and capital flows, some inefficient companies may also survive, thus optimal allocation of labor and capital between industries will becompromised. That is because when finding that an employee is not the best match, the employer will weigh the value created by the employee and the cost of recruiting. When the labor costs are relatively high, companies will pay a lot to dismiss employees and hire the optimal candidate, and therefore capital is trapped in inefficient companies. With the improvement of productivity and the substitution of capital for labor, the surplus labor in traditional sectors, agriculture and manufacturing, has to transfer to the tertiary or service sector. It can be seen that industries with the lowest productivity are perhaps the most labor-intensive. But utimately, the tertiary sector will overtake the other two sectors. For example, in some European countries, 80% of the total labor force is working in the service sector, and only 17% in manufacturing and 3% in agriculture.

2. Relations between technological progress, automation and employment

At present, many exciting and labor-saving new technologies are digital technologies. The United States is a leader in this regard, the Republic of Korea and Japan attach great importance to the development of digital technologies, and China also encourages technological innovation and developmentin IT application in its “Made in China 2025” plan.

Technological progress can increase productivity, but also brings problems. For example, will technology replace human labor and lead to unemployment? Technology cannot improve productivity to the same extent in all industries and all enterprises at the same time. Productivity may be improved faster in some industries and slower in others, and technological advances can create new jobs while destroying some existing ones. Due to the extensive application of automation and artificial intelligence in this round of industrial transformation, a large number of middle levelmanagement positions and technical jobs have been shattered. As a result, the middle class has seen their income decreasing, and those unemployed have moved to the service sector. As long as there are industrial innovations, there will always be workers who find their knowledge and skills outdated and businesses which are under the threat of bankruptcy. There is a positive trade-off between productivity growth and unemployment in the long run. Ultimately, the growth of productivity will lead to the reallocation of labor force and redistribution of wealth.

The government should play an active role in this process and provide training to help the workers learn new skills needed to cope with the transformation. Most of the new jobs will appear in service industries that cannot be automated at the moment, such as medical care, hotels, education, personal services, housekeeping and property management. The government should support small and medium-sized enterprises in these fields.

3. Labor mobility and trade protectionism

After the financial crisis, isolationism has emerged in some European and American countries, which is reflected in the rise of economictrade protectionism and the rise of power by right-wing conservative parties. Pissarides believes that international trade can promote the growth of service economy whiletrade frictions hold back the market economy. The barriers of the labor mobility has increased the gaps in labor cost and indirectly fuelled trade protectionism. The government should strengthen employment protection such as job training to reduce the comprehensive cost of labor mobility and promote cross-sector flows. At the same time, the government should create conditions for the labor force to improve their work skills.

4. No large-scale unemployment in China

China is now carrying out structural adjustments by cutting overcapacity and excess inventory, reducing costs, and working on other weakness. According to Pissarides, the number of manufacturing jobs is bound to decrease in the context of increased automation and mechanization. He believes that the efforts to “cut overcapacity and excess inventory, deleverage, reduce costs, and strengthen improving weakness” will surely deprive people of work in relevant enterprises, but those people will not stay unemployed because the service industry has a large demand for labor force. In other words, workers will flow between industries, and large-scale unemployment will not occur. Developed countries in Europe and America also experienced the transfer of workers from manufacturing to the service sector. Currently, over 70% of the total labor force is working in the service sector in these countries, compared with less than 50% in China, leaving much room for China to catch up.

II. Pissarides’ academic contribution

Unemployment is a common and important phenomenon in modern economy. Western economists have interpreted unemployment from different perspectives, and thus a variety of unemployment theories have taken shape, including the classic unemployment theory, Keynesian theory of unemployment, and monetarist theory of unemployment .

The search and matching theory has unified people’s understanding of frictional unemployment and structural unemployment, laying a microscopic foundation for the natural rate of unemployment. Pissarides’ book Equilibrium Unemployment Theory is an often quoted masterpiece in unemployment macroeconomics.

The search and matching theory is based on two assumptions: first, the workers and job vacancies are heterogeneous, and labor market information is incomplete. Both workers and enterprises must keep searching to get matched jobs and peoplerespectively. Second, with more search and matching targets, workers are more likely to get a satisfactory job, and employers are more likely to hire satisfactory workers. But search and matching involves costs such as time cost, transportation cost and information cost, which can be regarded as an investment of the labor force and enterprises. The search and matching theory argues that people can rationally choose to give up certain jobs and stay unemployed to await for a better job opportunity in the future.

Pissarides has used the male-female love relationship to explain his theory of unemployment, the process of job hunting is like finding love. Assuming a girl has broken up with a boy, she will need time to find the next boyfriend. Likewise, finding the next job also takes time. The search and matching theory describes the process in which one finds something or someone that best matches oneself and brings the best benefits.

III. Pissarides and China

Married to a Chinese wife, Mr. Pissarides understands Chinese culture well and he is a charismatic gentleman. He has extraordinary and pertinent insights to the difficulties embedded in China's economic development. In early 2016, he was received by Chinese Premier Li Keqiang.

During his visit to China in 2016, Pissarides pointed out in a public speech that despite the remarkable growth over the past decades, China’s development is still behind the United States and Europe. With the economic slowdown, a key issue is “what China can do to improve the average labor productivity.” He put forward the following proposals.

First, raise the productivity of the labor force, promote the structural transition to “efficient development”, and improve technology.

Second, address the large amount ofwaste in investment. China’s investment rate, averaging 45% of GDP, is greater than the 20% of the United States and European Union. Apart from the high proportion, the poor quality and massive waste of investment projects are also worrying.

Third, enhance China’s R&D capacity. In Japan and Germany, research investment of the private sector accounts for more than 2.5% and nearly 2% of GDP respectively, but the number is only about 1.4% in China. China lags behind the advanced economies in R&D, which is mainly reflected in fundamental researches of universities and private companies, but not government-dominated scientific research.