A key purpose of the labour market is to match the skills required by employers with the skills and capabilities of current and potential employees. This chapter looks at the way the demand for labour from employers matches the supply of labour from workers.

The chapter outlines three perspectives on how well the labour market is matching demand with supply: the Beveridge Curve – a traditional indicator of labour market matching, employers’ perspectives, and individuals’ perspectives.

Employer surveys are revealing. In 2021, to April, 45% of recruiting employers reported having recruitment difficulty for their most recent vacancies, a slight increase on 2019 (42%) but significantly higher than 2016, when it was just 36%. Recruitment difficulty has become more common outside capital cities in recent years, with rest-of-state recruitment difficulty exceeding that for capital cities in 2020 for the first time.

From the job seeker perspective, the analysis shows there are differences between the last job held by a person seeking work and jobs that are frequently advertised.

The chapter also describes early work by the NSC to understand how well market matching is working in the vocational education and training (VET) sector, through the VET National Data Asset (VNDA). The data provided by the VNDA will allow information on the outcomes of training to be risk-adjusted, taking into account the diversity of students, courses and providers within the sector.

The economic theory of labour market matching

One of the most useful conceptual frameworks for understanding the dynamics of the labour market is search and matching theory. This framework describes a theory behind labour market search and matching, including the role of key participants such as firms and individuals. This approach is otherwise known as the Diamond, Mortensen and Pissarides model, named after three economists who won the Nobel prize in 2010 for their work leading the development of the framework ³⁸.

In the framework, firms produce products and services for customers. In order to deliver these products and services, the firms require certain tasks to be completed, which require a particular skill set to deliver. Together, these tasks and skills constitute a job, and collectively across the economy, firms’ requirements for workers to complete these jobs constitute labour demand.

On the other side of the market, there are individuals who possess skills and capabilities. This may include skills developed through study or education or through previous work experience. These individuals also have preferences regarding the types of jobs they want to work in, and how they would like to participate in the labour market, for example, hours of work and job location. Together, these skills and preferences constitute available labour, or labour supply.

The labour market brings this labour supply together with labour demand from firms. Notably, both parties incur some costs in the matching process – for example, individuals have to spend time searching for a job, while firms incur advertising and recruitment costs including delayed productivity from on-the-job training. The labour market overall will be most efficient when there are good matches between workers’ and firms’ needs, and search costs are minimised.

Some degree of mismatch between demand and supply is unavoidable as labour market transitions can never be entirely seamless. It takes time for firms to advertise and recruit and similarly for individuals to search for, secure and be productive in a new job. Some mismatches are caused by imbalances between aggregate demand in the economy and aggregate supply. For example, during an economic downturn when business confidence is weak there is likely to be a surplus of labour supply relative to demand. This can come about through external shocks such as the global financial crisis and the COVID-19 pandemic. Structural imbalances are caused by the more persistent frictions in the labour market or entrenched obstacles that impede the efficient functioning of the labour market.

The factors influencing the mismatch between demand and supply are likely to be in play at any one point in time and can result in short, medium and longer-term matching inefficiencies. Although short-term mismatches may have minimal impacts on productivity and wealth, longer-term impacts caused by structural imbalances are of concern. Also, temporary shocks to the labour market can have persistent effects.

If potential workers (supply) are trained for a particular skill set or occupation but all the expanding firms (demand) require another skill set, then the matching process will be likely to be inefficient. As a consequence, the labour market will have simultaneously high unemployment and high vacancies. This has direct implications for the potential output of the economy as a whole. If there are persistent skill mismatches, overall economic output will be less than the potential output that could be produced given the overall labour supply. This shows how critical efficient labour market matching can be to an economy.