If there is a job shortage, why not just pay more?

Jobs and Skills Australia released this years Occupation Shortage List. I was excited to see that my occupation is in a shortage in the State I’m working in!

Now, to be honest the economist profession doesn’t feel like there is a shortage in Sydney. Walking down the street I hear the beautiful sounds of people discussing supply and demand on a regular basis. When looking for potential colleagues to work with there is always a stream of smart and articulate people, all of which I’d be happy to collaborate with at some point in the future.

So this made me think, how do we define a shortage? And in my digging I discovered that something pretty important is overlooked when these measures are constructed - wage growth.

tl;dr occupation shortage lists based on measures of vacancies, skill availability, and firm perceptions are valuable - but they need to be disciplined with actual information on wages. These quantity and opinion based measures alone do not tell us if a set of skills are scarce - the revealed preference associated with wages is the true tell.

Definition of a shortage

Jobs and Skills provides us with a methodology document that outlines how they define a shortage. The figure below indicates the set of characteristics they focus on in their most detailed measures.

Here measures related to labour availability (unemployed), vacancies, and skill complexity - along with a series of employment and population based flow measures - are used to describe the underlying supply and demand of workers in a given occupation.

This measure is combined with survey information relating to firm difficulty finding labour to generate the skills list we make use of. To put this into my most techincal economics, the goal of these measures is to measure the gap between these two curves on the diagram below.

A shortage is where there appears to be vacancies - this makes sense

Definitely. When we think about measures of labour market tightness we talk about V/U - or the number of vacancies divided by the number of unemployed people that fill those roles. Including flow data on job finding rates can then be used to evaluate aggregate labour market “matching efficiency”, helping to build insights about how effective labour market conditions are at matching individuals with jobs.

If we think like that in the macroeconomy, we could surely use the same concept for individual industries.

Or can we.

Individuals have a bundle of skills that can be used to undertake tasks that are embedded in these jobs. People can be incentivised to switch where they supply their skills on the basis of the wage they can earn.

This substitutability between jobs suggests that, for individual industries, if there is a shortage we really should expect the relative wage in that industry to start climbing to attract workers.

Industry by industry, firm by firm, the nature of competition or the structure of the production process could lead to varying patterns of vacancies irrespective of a shortage. But universally, a shortage in one industry should lead to the price of labour in that industry to be bid up.

Using our supply and demand curve above, the shortage should either start to generate rising wages OR we should be able to describe the constraint that is leading to a persistent gap (i.e. public wage setting, monopolistic competition). Once we identify these reasons we can then identify whether there is a related market failure, and use these measures to inform policy.

The difficult thing with measure it at the job level is that any adjustment would then start to spillover onto other firms/related occupations. But that is the point. The shortage is in a set of skills rather than a specific job and that will show up in the remuneration for those skills going up. We discussed this in detail when asking how we judge whether our pay is “good”.

That’s dumb - wages adjustments are not found empirically

Now the people at Jobs and Skills are clued on, they haven’t forgotten about wages they are instead relying on empirical assessments in Australia that indicate limited wage response to such shortages. This is discussed in the most recent Occupational Shortage Report (page 17).

In fact, when I was a young economist I remember DEWR was working on similar things and commissioned Melbourne Institute to look into this - I saw this in my first year working on labour economics in New Zealand, as we were always keeping an eye on our big brothers here for insights.

The argument is that Australia’s unique institutional settings blunt market signals. Enterprise Bargaining Agreements break the link between wages and shortages, and so relative wage growth cannot be used to judge shortages.

The MI report finds this is not the case - although it weakens the response wage growth is still useful for assessing such shortages.

Furthermore, a persistent higher level of wages for a given set of skills would also be evidence of a shortage - even if growth was no different.

To be frank, if Australia’s institutional structure was so uniquely broken that wages have little relationship to the value of the tasks undertaken then Australia has a fairly major economic problem. And if we truly believe that Australia does have uniquely broken institutional settings I am unsure why this isn’t the focus of recommendations?

However, given how wealthy the country is I find this dubious.

Instead, if firms are unwilling to put their money where there mouth is to “fill a skill gap”, then I don’t really care what random filler text their CFO has put in a survey - there isn’t a real shortage.

Or let me frame this another way - it is sometimes said that wage measures are a poor measure of scarcity as they do not correlate well with these types of constructed measures. But can’t this be interpreted as simply saying that constructed measures are bad?

As price represents scarcity, if your scarcity measure doesn’t relate to price you have a problem - not the price!

If we want a measure that is useful for policy, then we need to know what skills are scarce. To understand what skills are scarce, we need to identify where intense labour market pressure has driven up the returns on those skills.

But doesn’t vacancies just give you the same information

Imagine two situations.

There is one worker who has a very unique set of skills, lets call them Bryan Mills. A firm manages to hire that worker - they provide them amazing pay and conditions, and make sure to keep them. Other firms want Bryan, but they know they can’t have him - so they don’t bother paying to make a vacancy and make do without.

Here we have scarcity, with no vacancies - and it shows up in the wage.

In another situation we have a series of workers, lets call them Matts. They have easily substitutable skills and they are everywhere - constantly writing about economics say. These Matt’s sometimes leave their jobs for a break, and when they do so firms just throw out an advert looking for another Matt - and another Matt always appears, we just have to wait for them to stop their little holidays.

Here we have limited scarcity, but we have a lot of vacancies - something that will show up in low wages for Matts.

Imperfect competition and the complex nature of skills make these links complex. But wage rates - when including the value of amenities (i.e. flexibility, working from home) and non-wage financial support - can provide a cast iron measure of this.

If you disagree, good - I’d love to hear your insights and maybe learn a thing or two in the comments below :)