The forces driving labor market inequality: challenges and solutions
Jul 2025
Enabling world-class research
In his research, Andreas I. Mueller delves into the complexities of the labor market, addressing key issues such as the sharp rise in unemployment during recessions, persistent wage inequality among similar workers, and the effects of labor market policies. His work bridges macroeconomics and labor economics to offer new insights into how economic cycles, wage bargaining, and policy interventions shape employment outcomes. By exploring these unresolved questions, Mueller aims to develop more effective policies to manage labor market challenges and foster sustainable economic growth.
Pressing challenges to address
- Why does unemployment rise sharply during recessions?
- What explains the substantial wage differences among similar workers?
- Do labor market policies have offsetting or amplifying effects at the macroeconomic level?
Unemployment dynamics during economic recessions
My research lies at the intersection of macroeconomics and labor markets, often referred to as “macro-labor.” This field studies the determinants of unemployment, job vacancies, and wages at the macroeconomic level. In my view, three fundamental questions in my field remain unresolved.
First, why does unemployment rise so sharply during recessions? The labor market’s boom-bust cycle is exceptionally pronounced, and traditional economic models of labor supply and demand struggle to fully explain this phenomenon. Unemployment – representing workers willing to work but unable to find jobs – is unlikely to stem from labor supply decisions alone but instead points to disequilibrium or the existence of search frictions in the labor market. A common explanation for the sharp rise in unemployment is wage rigidity: If firms cannot reduce wages during downturns, they may opt to lay off workers or freeze hiring. However, the debate on wage rigidity is far from settled. While aggregate wages appear relatively acyclical, recent research shows that wages for newly hired workers are far more responsive to business cycles. This raises doubts about wage rigidity as the sole explanation and highlights the need for further investigation.
Wage inequality among similar workers
Second, why do similar workers earn such different wages? Despite significant progress in understanding wage inequality across groups – such as by education level or gender – a substantial portion of wage disparity remains unexplained. The classical supply-and-demand framework suggests that wages reflect worker productivity, but this fails to account for the substantial wage differences observed among seemingly similar workers at different firms. Two main alternative theories attempt to explain the high dispersion of wages among similar workers. First, compensating differentials suggest that firms pay workers of similar ability differently to account for variations in workplace conditions and job disutility. Second, workers’ outside options play a crucial role in wage bargaining. Factors such as alternative employment opportunities, household circumstances, or wealth can thus lead to significant differences in wage-bargaining outcomes among workers with similar observable characteristics. Understanding these mechanisms better is essential to understanding and addressing wage inequality.
The impact of labor market policies
Third, do labor market policies have offsetting or amplifying effects at the macroeconomic level? A wealth of microeconomic research has examined how labor market policies, such as unemployment insurance or job search counseling, influence individual incentives to seek employment. For example, studies consistently show that more generous unemployment insurance reduces job search efforts and job-finding rates. More generous unemployment benefits thus should lead to a higher unemployment rate as unemployed workers take longer to find jobs. However, these studies often overlook general equilibrium effects that emerge when policies are implemented at scale. For instance, more generous unemployment insurance may stimulate local economies as unemployed individuals spend more, potentially offsetting negative incentives and boosting job creation. Conversely, it may discourage firms from hiring due to increased difficulty in finding workers or higher wage demands, further amplifying the effect on unemployment. Understanding these general equilibrium effects is crucial for determining whether unemployment insurance should be expanded during recessions.
In general, addressing these unresolved questions is essential for developing more accurate models and effective policies to navigate the key labor market challenges.
The need for improved data and causal inference
What is required to address these challenges and resolve these questions? What is urgently needed is better and more comprehensive measurement to enhance and refine our economic models of the labor market. Allow me to elaborate.
First, macroeconomic or aggregate data can often mislead our understanding of how economic agents behave and interact within the labor market. Let me give you an example: The average real wage reported by statistical agencies is acyclical in many countries, suggesting that real wages do not respond to labor market booms and busts. This has traditionally been interpreted as evidence of wage rigidity. However, this interpretation is flawed because more low-wage workers are affected by job losses during recessions and thus those who remain employed tend to earn higher wages. By analyzing large-scale microeconomic datasets from surveys or administrative sources, we see that real wages are more cyclical at the individual level than the aggregate data suggests. Additionally, wages for newly hired workers are more responsive to economic cycles compared to those of incumbent workers. These findings highlight the importance of accounting for heterogeneity among workers and firms to better understand the microeconomic mechanisms underlying aggregate labor market dynamics. Achieving this requires detailed and careful analysis of representative and high-quality datasets.
Second, labor market policies implemented at scale are often endogenous to the state of the labor market – such policies are typically introduced when unemployment is high. This creates a challenge of reverse causality, making it difficult but not impossible to evaluate their true impact. The gold standard for causal inference in microeconomics is randomized controlled trials (RCTs), but applying this approach at the macroeconomic level is more complex and costly because treatments must be scaled up to affect entire markets or regions. Despite these difficulties, there is growing interest in applying RCTs to macroeconomic questions, particularly in areas such as job search counseling. For unemployment insurance, RCTs are harder to implement, but researchers can exploit discontinuities or institutional reforms across regions within a country to address reverse causality and estimate the effects of unemployment insurance on labor market outcomes at the macroeconomic level.
In sum, I believe that advancing our understanding of the labor market requires both improved data and innovative approaches to causal inference, enabling us to build more accurate and effective economic models.
The challenges of data and theory integration
Why do these questions remain unresolved? The process of gathering highquality data sources and conducting meticulous empirical analysis demands significant resources in terms of both time and funding – often exceeding what an individual researcher can accomplish during the period of a PhD for example. Exploring a new dataset or conducting a survey typically involves considerable career risks. While access to high-quality datasets is steadily increasing, it remains restrictive in many instances. Ensuring data confidentiality is, of course, paramount, but access to administrative sources often remains slow and unpredictable. Encouragingly, initiatives aimed at improving access and harmonizing datasets across countries are gaining traction, signaling positive progress in the field.
In addition, macroeconomics has a long tradition of economic modeling, but empirical analysis has not always been warmly embraced. Conversely, applied economists often criticize theoretical models, arguing that they are sometimes disconnected from real-world complexities. I believe it is crucial to advance both aspects – testing the key predictions of theoretical models and refining them through better and more comprehensive data. Relying solely on theory without data is risky, just as using data without the guidance from theoretical frameworks can be misleading, especially in macroeconomics, where numerous interacting forces are at play. In essence, progress in addressing unresolved questions in my field requires both better data and more robust theory.
Understanding unemployment and its societal impact
What personally drives your research? The existence of unemployment – individuals that would like to work but can’t find work – in modern market economies is at odds with the classical paradigm of supply and demand. At the same time, unemployment has tremendous individual costs on income, consumption, and psychological well-being. From a macroeconomic perspective, unemployment represents a massive unused resource. For all these reasons, I believe understanding all the factors that influence unemployment, particularly the role of labor market policies, and the reasons why unemployment rises so much in recessions are incredibly important questions that demand better and more comprehensive answers.
The role of the UBS Center in advancing research
The UBS Center is dedicated to excellence in research and has played a pivotal role in attracting top talent in the field of economics since its establishment. I feel fortunate to be part of an environment enriched by outstanding colleagues and students, many of whom owe their presence here to the UBS Center and the professorships supported by its foundation. The center’s vision and unwavering dedication to excellence sets a high standard for everyone involved, inspiring us to take bold steps in addressing the most pressing and unresolved questions in our fields. In addition, the UBS Center serves as a vital bridge between the academic world and the public, fostering meaningful interactions that, in my view, are immensely beneficial for both sides.
In his research, Andreas I. Mueller delves into the complexities of the labor market, addressing key issues such as the sharp rise in unemployment during recessions, persistent wage inequality among similar workers, and the effects of labor market policies. His work bridges macroeconomics and labor economics to offer new insights into how economic cycles, wage bargaining, and policy interventions shape employment outcomes. By exploring these unresolved questions, Mueller aims to develop more effective policies to manage labor market challenges and foster sustainable economic growth.
Pressing challenges to address
- Why does unemployment rise sharply during recessions?
- What explains the substantial wage differences among similar workers?
- Do labor market policies have offsetting or amplifying effects at the macroeconomic level?
Unemployment dynamics during economic recessions
My research lies at the intersection of macroeconomics and labor markets, often referred to as “macro-labor.” This field studies the determinants of unemployment, job vacancies, and wages at the macroeconomic level. In my view, three fundamental questions in my field remain unresolved.
First, why does unemployment rise so sharply during recessions? The labor market’s boom-bust cycle is exceptionally pronounced, and traditional economic models of labor supply and demand struggle to fully explain this phenomenon. Unemployment – representing workers willing to work but unable to find jobs – is unlikely to stem from labor supply decisions alone but instead points to disequilibrium or the existence of search frictions in the labor market. A common explanation for the sharp rise in unemployment is wage rigidity: If firms cannot reduce wages during downturns, they may opt to lay off workers or freeze hiring. However, the debate on wage rigidity is far from settled. While aggregate wages appear relatively acyclical, recent research shows that wages for newly hired workers are far more responsive to business cycles. This raises doubts about wage rigidity as the sole explanation and highlights the need for further investigation.
Andreas I. Mueller is a Professor of Macroeconomics and Labor Markets in the Department of Economics at the University of Zurich and an Affiliated Professor at the UBS Center.
Quote
Unemployment represents a massive unused resource in modern market economies.
Economic challenges of our time
From rising inequality and global trade tensions to climate change and the impact of artificial intelligence on labor markets – economists today are grappling with fundamental questions that will shape our collective future. In this special edition of the Public Paper series, all affiliated professors of the UBS Center share their perspectives on these challenges. Their contributions highlight how cutting-edge research conducted at the Department of Economics at the University of Zurich can help us better understand – and potentially solve – some of the most urgent issues of our time.
It is precisely this ambition that defines the UBS Center for Economics in Society. Since its founding, the Center has served as a platform for dialogue between academia, business, and policymakers and as a catalyst for excellence in economic research. That vision goes back to Kaspar Villiger. As the founding Chairman of the Foundation Council, he played a pivotal role in establishing and shaping the UBS Center.
With this fifteenth edition of the Public Paper series, we honor Kaspar Villiger’s extraordinary contributions and legacy. By strengthening research capacity at the University of Zurich and fostering public dialogue around key societal questions, his vision continues to inspire the Center’s mission: bridging knowledge and society to build a better future.
From rising inequality and global trade tensions to climate change and the impact of artificial intelligence on labor markets – economists today are grappling with fundamental questions that will shape our collective future. In this special edition of the Public Paper series, all affiliated professors of the UBS Center share their perspectives on these challenges. Their contributions highlight how cutting-edge research conducted at the Department of Economics at the University of Zurich can help us better understand – and potentially solve – some of the most urgent issues of our time.
It is precisely this ambition that defines the UBS Center for Economics in Society. Since its founding, the Center has served as a platform for dialogue between academia, business, and policymakers and as a catalyst for excellence in economic research. That vision goes back to Kaspar Villiger. As the founding Chairman of the Foundation Council, he played a pivotal role in establishing and shaping the UBS Center.
Andreas I. Mueller on Google Scholarbrowse
The causes and consequences of long-term unemployment
Author
Professor of Macroeconomics and Labor Markets
Andreas I. Mueller holds the Professorship for Macroeconomics and Labor Markets at the Department of Economics at the University of Zurich and is an Affiliated Professor at the UBS Center for Economics in Society. Prior to joining the University of Zurich, he was an Associate Professor at UT Austin and Columbia Business School. Mueller received his doctorate from the IIES, Stockholm University, and was awarded the Arnbergska Prize for his dissertation work by the Royal Swedish Academy of Sciences. His research spans a broad spectrum of issues in macroeconomics, labor economics, and monetary economics and has been published in leading academic journals such as the American Economic Review, Econometrica, the Journal of Political Economy and the Review of Economic Studies and covered in the Economist, New York Times, Wall Street Journal and Financial Times. Professor Mueller is a Research Affiliate at the Center for Economic Policy Research (CEPR), a Research Fellow at the Institute of Labor Economics (IZA), and an Associate Editor at the Swiss Journal of Economics and Statistics and the Journal of Monetary Economics.
Professor of Macroeconomics and Labor Markets
Andreas I. Mueller holds the Professorship for Macroeconomics and Labor Markets at the Department of Economics at the University of Zurich and is an Affiliated Professor at the UBS Center for Economics in Society. Prior to joining the University of Zurich, he was an Associate Professor at UT Austin and Columbia Business School. Mueller received his doctorate from the IIES, Stockholm University, and was awarded the Arnbergska Prize for his dissertation work by the Royal Swedish Academy of Sciences. His research spans a broad spectrum of issues in macroeconomics, labor economics, and monetary economics and has been published in leading academic journals such as the American Economic Review, Econometrica, the Journal of Political Economy and the Review of Economic Studies and covered in the Economist, New York Times, Wall Street Journal and Financial Times. Professor Mueller is a Research Affiliate at the Center for Economic Policy Research (CEPR), a Research Fellow at the Institute of Labor Economics (IZA), and an Associate Editor at the Swiss Journal of Economics and Statistics and the Journal of Monetary Economics.