Abraham Katherine G., and Henry S. Farber, “Job Duration, Seniority, and Earnings,” American Economic Review, Vol. 77 (June 1987), pp. 278 –l97.
Atkinson, Anthony B., “On the Measurement of Inequality,” Journal of Economic Theory, Vol. 2 (September 1970), pp. 244 –63.
Bettola, Giuseppe, “Flexibility, Investment, and Growth,” (unpublished; Princeton, New Jersey: Princeton University, 1991).
Blanchard, Olivier J., and P. A. Diamond, “The Cyclical Behavior of Gross Flows of U.S. Workers,” Brookings Papers on Economic Activity 2 (1990), The Brookings Institution, pp. 144 –53.
Blanchard, Olivier J., and Lawrence H. Summers, “Fiscal Increasing Returns, Hysteresis, Real Wages and Unemployment,” European Economic Review. Vol. 31 (April 1987), pp. 543 –50.
Burda, Michael, and Charles Wyplosz. “Gross Workers and Job Flows in Europe,” European Economic Review, Vol. 38 (June 1994), pp. 1287 –1315.
Davis, Steven J., and John Haltiwanger, “Gross Job Creation, Gross Job Destruction, and Employment Reallocation,” Quarterly Journal of Economics, Vol. 107 (August 1992), pp. 819 –64.
Hall, Robert E., “The Importance of Lifetime Jobs in the U.S. Economy,” American Economic Review, Vol. 72 (April 1982), pp. 716 –24.
Jovanović, Boyan, “Job Matching and the Theory of Turnover,” Journal of Political Economy, Vol. 87 (October 1979), pp. 972 –90.
Layard, P.R.G., S.J. Nickell, and Richard Jackman, Unemployment: Macroeconomic Performance and the Labor Market (Oxford: Oxford University Press, 1991).
Ortega, Javier, “Loss of Skill During Unemployment, Complementarities in Production, and Persistence of Shocks,” DELTA Working Paper No. 93–26 (Paris: DELTA, Ecole Normale Supérieure, December 1993).
Saint-Paul, Gilles, “On the Political Economy of Labor Market Flexibility,” in NBER Macroeconomics Annual 1993, ed. by Olivier Blanchard and Stanley Fischer (Cambridge, Massachusetts: MIT Press, 1993).
Gilles Saint-Paul is a researcher with CERAS and DELTA and a fellow of the Center for Economic Policy Research. DELTA is a joint research unit of ENS-CNRS-EHESS. This paper was written while he was a visiting scholar at the IMF’s Research Department. Its main theme was suggested by David Coe and Robert Ford, and it has benefited from discussions with José De Gregorio.
For an analysis of the political issues in increasing labor market flexibility with an emphasis on complementarities, see Saint-Paul (1993).
In principle, the problem could be alleviated by raising the tax rate in the skilled market, in accordance with the prescriptions of optimal second-best taxation.
This would be the case in an open economy with capital mobility. The marginal product of capital would then be equal to the world rate of interest.
As emphasized by Ortega (1993), there is no canonical way of labeling workers as “skilled” or “unskilled” as long as they are not perfect substitutes.
Note that the model exhibits “fiscal increasing returns” as analyzed in Blanchard and Summers (1987): an increase in the unemployment rate lowers the tax base, which for a given target for unemployment benefits calls for an increase in taxes, which leads to further increases in unemployment.
Given that there are only two skill levels in the economy, there is no clear-cut way to calibrate x. If one takes the number of people earning the minimum wage as a guideline, then 0.5 is too low for x, since the minimum wage will then Be binding for 50 percent of the labor force. However, if one takes the proportion of workers with higher education as an alternative criterion, then 0.5 is too high.