Unemployment and Policy Neutrality under Competition

This paper argues that involuntary unemployment can persist under competition; namely, if the ability of workers to commit themselves is limited and it is more costly for firms to provide information about the quality of unemployed than of employed workers. The problem is that, unless unemployment is high, firms prefer to recruit by bidding up the wage on already employed workers. The problem is that, unless unemployment is high, firms prefer to recruit by bidding up the wage on already employed workers, rather than engage in costly search for acceptable unemployed. Involuntary unemployment can, furthermore, resist standard economic policy instruments: situations may occur in which equilibrium unemployment does not respond to demand shocks or standard supply-side policy such as changes in unemployment benefit. In these situations only institutional changes concerning the firms' recruiting behavior and the ability of workers to commit themselves, can influence the level of equilibrium unemployment.