Loss of Skill and Labor Market Fluctuations

By Etienne Lalé


This paper studies the effects of skill loss on compositional changes in the pool of unemployed, and their impact on aggregate labor market fluctuations. We develop a computationally tractable stochastic version of the Diamond-Mortensen-Pissarides model, wherein workers accumulate skills on the job and lose them during unemployment. Skill loss provides a mechanism for amplifying fluctuations: the loss of skills shifts the average composition of the unemployment pool towards low-surplus workers, which magnifies the response of vacancies to aggregate productivity shocks. The model, however, cannot generate large compositional changes at business cycle frequency: the dynamics of unemployment remains too fast for the pool of searching workers to deteriorate markedly during downturns. Finally, we find that loss of skill plays a quantitatively important role if skills are destroyed immediately upon job loss, and more so during recessions.

This is an interesting paper. However, it is calibrated to the US economy before 2007, that is, an economy with really short unemployment duration. Since then, long term unemployment has become a more prominent feature of the labor market, like in other developed economies. Large compositional changes should be possible in such circumstances and an appropriate experiment should be included in the paper.


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