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The labor search and matching model plays a growing role in macroeconomic analysis. This paper provides a critical, selective survey of the literature. Four fundamental questions are explored: how are unemployment, job vacancies, and employment determined as equilibrium phenomena? What determines worker flows and transition rates from one labor market state to another? How are wages determined? What role do labor market dynamics play in explaining business cycles and growth? The survey describes the basic model, reviews its theoretical extensions, and discusses its empirical applications in macroeconomics. The model has developed against the background of difficulties with the use of the neoclassical, frictionless model of the labor market in macroeconomics. Its success includes the modelling of labor market outcomes as equilibrium phenomena, the reasonable fit of the data, and when inserted into business cycle models improved performance of more general macroeconomic models. At the same time, there is evidence against the Nash solution used for wage setting and an active debate as to the ability of the model to account for some of the cyclical facts.

The phenomenon of workers moving from a poor to a rich economy is high on the political agenda. When a worker moves to a richer economy, what is gained by the move? The empirical challenge in giving an answer stems from the difficulty to disentangle income differences from many other determinants. Estimates are potentially biased due to substantial misspecification of the model, when omitting relevant determinants. The paper makes use of a unique data set on Palestinian workers, working locally and in Israel, that allows to isolate the pure effects of income differences with no other relevant factors. It explicitly addresses the question of what workers newly experience in the richer economy (higher productivity), what is taken from the poorer economy (human capital), and their choices in moving (self-selection). Importantly, it encompasses the constraints placed on workers in terms of the human capital skills demanded. The findings show that income differences affecting worker choice are made up of contradictory elements. Consistently with findings in the development accounting literature, productivity differences in favor of the richer economy, due to differences in TFP and in physical capital, are sizeable and operate to raise wages for movers. But lower job task values operate to lower wages for movers, who are offered manual tasks in the rich economy. The latter loss offsets the former gain. The paper emphasizes the idea that tasks are tied to locations. Workers choose a location-wage-task 'pack,' with movers getting low rewards to the skills bundled in their job tasks.

Work of low-skilled migrant workers from developing countries in developed economies is a growing phenomenon and a key political and economic issue. An extensive literature has found (for the most part) that these workers come from the lower part of the skill distribution. This paper revisits the issue, using a self-selection model, a unique data-set on migrant workers as well as on workers that chose not to migrate (?stayers?), and direct estimation of the moments of the latent unobserved skill distributions. The main findings are that there are two dimensions to self-selection: in terms of observed skills, a substantial migration premium lures migrant workers, while very low returns to skills in the foreign economy deter skilled workers, leading to negative self-selection. In terms of unobservable skills, self-selection is found to be positive rather than negative. The latter finding entails substantial increases in mean wages and reduction in wage inequality, relative to random assignment and to the alternative of not migrating. The analysis also demonstrates that estimates of skill premia for migrants – an important issue in the immigration literature – are upward biased if selection is not accounted for. Relevant skills are multi-dimensional, hence assignments in this context are non-hierarchical.

The paper explores the consequences of macroeconomic policy for labor market outcomes in the presence of frictions. It shows how policy may be useful in overriding frictions, as well as how it might generate adverse outcomes. The analysis looks at the main tools of macroeconomic policy and pertains to both the non-stochastic steady state and to business cycle fluctuations. A partial-equilibrium, empirically-grounded model is used to simulate policy effects. It relies on a reduced-form VAR of the actual data to specify the stochastic behavior of exogenous variables, precluding the possibility that labor market results will be affected by misspecifications in other parts of a more general macroeconomic model. The key results are that policy has effects on the stochastic behavior of key variables - measures that reduce unemployment also reduce its persistence and increase the volatility of vacancies. Hiring subsidies and unemployment benefits have substantial effects on labor market outcomes, while employment subsidies or wage tax reductions are not very effective policy instruments.

The paper takes the search and matching model of the aggregate labor market to the data. It tests the model's empirical validity and employs structural estimation to generate a characterization of the optimal behavior of firms and workers. The model is applied to Israeli data that are uniquely suited for this kind of empirical investigation. The structural estimates are used to quantify the frictions embodied in the model, including the costs of search, the congestion and trading externality effects, and the matching process. A calibration-simulation analysis then studies the effect of several key variables on equilibrium unemployment. (JEL E24, E32, J63, J64)