Underemployment equilibrium

The concept of underemployment equilibrium originates from analyzing underemployment in the context of General Equilibrium Theory, a branch of microeconomics. It describes a steady economic state when consumptions and production outputs are both suboptimal – many economic agents in the economy are producing less than what they could produce in some other equilibrium states.[1] Economic theory dictates that underemployment equilibrium possesses certain stability features under standard assumptions[2] – the “invisible hand” (market force) can not, by itself, alter the equilibrium outcome to a more socially desirable equilibrium.[3] Exogenous forces such as fiscal policy have to be implemented in order to drive the economy to a better state.

In an economy ${\displaystyle E=((u^{h},e^{h})_{h},(Y^{f},(\theta ^{f}h)_{h})_{f})}$: every economic agent h has a utility function ${\displaystyle u^{h}}$ and an initial endowment of wealth ${\displaystyle e^{h};}$ every firm f has a production function ${\displaystyle Y^{f};}$ every agent’s share of firm f is ${\displaystyle (\theta ^{f}h)_{h}.}$ An underemployment equilibrium, given a price vector p, is defined as the consumption-production vector ${\displaystyle (x^{*},y^{*})}$ such that [4]

For every firm f, producing ${\displaystyle y^{*}}$ maximizes its profit

For every economic agent h, consuming ${\displaystyle x^{*}}$ maximizes its utility

The market clears, meaning that the sum of optimal consumptions of all agents, ${\displaystyle \sum x^{*}}$ , equals to the sum of their initial endowments, ${\displaystyle \sum e^{*},}$ plus the sum of optimal profits for all firms, ${\displaystyle \sum y^{*}.}$[1]

Overqualification is the most common form of underemployment equilibrium and is a direct result of oversupply. It defines the situation when individuals work in professions which require less education, skill, experience or ability than they possess. In economic terms, these agents are producing less than their socially optimal output. Collectively, when a lot of individuals produce below their full potential, the economy is in a sub-optimal underemployment equilibrium.[5]

Overstaffing refers to the state when firms in an economy are hiring more people than they need. This is much less common than overqualification. This redundancy invalidates unemployment rates as a signal for the existence of underemployment equilibrium. When firms are overstaffed, they can not achieve their maximum profit levels, which leads to undesirable social consequences such as low GDP growth.[6]

During the 1930s, Great Depression, U.S. unemployment rate reached 25% and GDP growth rate fell to −13%.[7] The U.S. economy at this period can be characterized by an underemployment equilibrium. On the one hand, many outside forces (including financial instability, hyper-inflation, lack of capital, etc.) created a negative shock to the demand of job market. On the other hand, the first two decades of the 20th century saw rapid advancement in production technologies, which effectively eliminated a large number of skilled jobs. Both of the above forces help create an insufficient demand of labor market during that time, causing an underemployment equilibrium. This particular underemployment equilibrium takes form of overqualification, characterized by high unemployment rate and low household incomes.

Graduates entering the job market in 2012 faced very tough competitions[8], caused by an oversupply of skilled workers, including fresh graduates and people who were laid off during the 2008 financial crisis. Graduates did not have enough time to respond to the 2008 financial crisis and continued to finish their degrees, only to find that there are not enough jobs upon graduation. This underemployment equilibrium state is characterized by overqualification – many college graduates are taking positions designed for less educated individuals due to gloomy job market conditions.[8]