Working Paper Summaries 94/64: Are the Unemployed Unemployable?

The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.

Abstract

The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.

The problem of persistent and high unemployment is particularly acute in Europe and does not seem about to disappear. A common view is that the unemployed are “unemployable”: they lack the skills that are demanded in the labor market because of technological advances.

This paper provides some theoretical foundations for this view and suggests that it is more valid if the labor market is rigid in the sense that hiring decisions are irreversible. A matching model in the spirit of Diamond (1982), Blanchard and Diamond (1990), and Pissarides (1990) is developed where real but not relative wages are rigid, and where it is costly or impossible to fire workers. This irreversibility, along with the assumption of decreasing returns and real wage rigidity, generates an arbitrage condition in terms of the relative unemployment rate of the unskilled: the unskilled must be relatively more abundant than the skilled in order for firms to want to hire them. The main results are the following: first, when the relative productivity of the skilled increases, the unskilled unemployment rate increases, the skilled unemployment rate decreases, and aggregate unemployment unambiguously increases if firing costs are high enough. Second, when the proportion of skilled workers in the labor force rises, the unemployment rate for both the skilled and the unskilled increases. As a result, aggregate unemployment will only decrease if the initial proportion of skilled workers is quite high. Third, these effects are weaker when firing costs go down.

The model implies that technological advances may generate unemployment through two channels: by increasing the productivity of the skilled relative to the unskilled, and by increasing the supply of skilled workers in the economy. What renders the unskilled “unemployable” is that the firm makes less profit from them and is stuck with them. Hiring an unskilled worker entails a capital loss which is greater when their relative productivity is lower and when the skilled are found more easily.

Another implication of this model is that the return to becoming skilled increases when there are more skilled workers.

Training programs for the unskilled have been advocated as a means to reducing unemployment. However, the model suggests that the effect may be perverse unless the productivity of the whole of the unskilled labor force is increased. This suggests that an improvement in the quality of the school system has a better chance of reducing unemployment than limited training programs.

Working Paper Summaries (WP/94/1 - WP/94/76)
Author: International Monetary Fund