Tyler Cowen asks what is wrong with the labor market. He points to David Leonhardt, who writes,

the downturn has still exacted a much harsher toll on the less educated. The unemployment rate for college graduates is still just 4.5 percent, and the gap between their pay and everyone else’s is larger than it has ever been. For most college graduates, the Great Recession has not lived up to its name.

Health care now approaches 20 percent of the economy. With health insurance included in compensation, that means that 20 percent of compensation is determined not by your skill level, but by the median cost of health insurance. If the value of your skills has been rising faster than the median, then maybe that is not a problem. However, if the value of your skills has been rising more slowly than the median, then your skill level is no longer enough to overcome the health insurance hurdle.

Let the worker’s subjective valuation of health insurance equal V. Let the cost of health insurance equal C. Let the marginal product of labor equal M. Let the opportunity cost of the worker’s time equal W. Then we have:

M – C ?= W – V

The worker takes the job if and only if the left-hand side exceeds the right-hand side. If the excess of the worker’s marginal product over the cost of health insurance is not greater than the worker’s take-home wage requirement less the worker’s subjective valuation of health insurance, then the worker will not be employed. That may be what we are seeing today.

For example, suppose that your marginal product is \$25,000, but the cost of employer-paid health insurance is \$15,000. The means that the employer can only afford to give you pay net of health insurance costs of \$10,000. Suppose that you would not pay more than \$5,000 for health insurance if you paid for it yourself. Then the value of the job to you is \$10,000 + \$5,000 = \$15,000. If you value your time at more than \$15,000, then you will not take the job.

It is not that the marginal product of workers is close to zero. It is that the marginal product of workers is close to the median cost of health insurance, and workers do not value health insurance that highly.

[UPDATE: Nice sentences from Steven Horvitz:

What exactly government is supposed to do to “directly employ” unemployed folks with these highly specific skills? I really am waiting for someone to argue government should pay them to build websites and databases and then just delete what they’ve done.]