Labour market skills, endogenous productivity and business cycles

Abstract

This paper analyses how labour market heterogeneity affects unemployment, productivity and business cycle dynamics. To this aim, we set up a model with asymmetric search and matching frictions across skilled and unskilled workers, and endogenous productivity through R&D investment and intangible capital accumulation. Skill mismatch and skill-specific labour market institutions have three main effects on business cycles and growth dynamics. First, the relative scarcity of skilled workers increases the natural rate of unemployment and reduces total factor productivity with long-run effects on the growth rate of output. Second, skill heterogeneity in the labour market generates asymmetric outcomes and amplifies measures of employment, wages and consumption inequality. Finally, the model provides important insights for the Phillips and Beveridge curves. Incorporating skill heterogeneity leads to a flattening of the Phillips curve as wages and unemployment respond unevenly across skill types. Also, the model generates sideward shifts of the Beveridge curve following business cycle shocks, with the extent of these shifts depending on the degree of skill heterogeneity.