The Cost of Human Capital Depreciation During Unemployment

Abstract

Abstract. Skill erosion during unemployment was of particular concern as unemployment duration increased in the Great Recession. I argue that it generates an externality in job creation: firms ignore how their hiring decisions affect the unemployment pool's skill composition, and hence the expected output produced by new hires. As a consequence, job creation is too low from a social point of view. But the extent to which it is too low varies over the cycle. This is because the externality's magnitude, which depends on the impact of job creation on the pool's skill composition, reduces when the share of unemployed workers who already have eroded skills increases.

Optimal Monetary Policy in the Presence of Human Capital Depreciation During Unemployment

“…This can be explained when looking at the nature of the externality generated by skill erosion during unemploy-ment. Laureys (2012) shows that this externality can be offset by implementing a procyclical employment subsidy, reflecting that when the composition externality is the only source of inefficiency overall job creation is too low from a social point of view but less so in recessions than in booms. As can be seen from equation (13), the intermediate good firms' job creation depends positively on the real marginal revenue product generated by the newly hired worker.…”

“…Therefore, there is no interaction between the congestion and the composition effect, enabling the same condition to offset the congestion externality. For more details see Laureys (2012).…”

“…This is because human capital depreciation during unemployment generates a composition externality in job creation when firms cannot direct their search to workers with or without depreciated human capital as shown in Laureys (2012). 13 The composition externality arises since firms' job creation decisions today affect the skill composition of the unemployment pool in the next period, and hence the expected productivity of other firms' new hires.…”

“…Optimal price setting implies that each final good firm sets his price in every period as a constant markup over its nominal marginal cost. Taking into account that the nominal marginal cost of each final good firm is given by the price of the intermediate good P I t , optimal price setting 13 Laureys (2012) provides an analysis of the composition externality in a search and matching model à la Diamond-Mortensen-Pissarides with aggregate uncertainty and human capital depreciation during unemployment.…”

Human Capital Dynamics and the U.S. Labor Market

“…Laureys (2012) finds that the loss of skill during unemployment generates an externality in job creation. Chang, Gomes, and Schorfheide (2002) show that incorporating skill accumulation improves the ability of an RBC model to fit the dynamics of aggregate output and hours.…”