This paper extends the canonical search-and-matching mo del which has only a representative worker by including fragmented labour markets for skilled and unskilled workers. The production is characterised by capital-skill complementarity: the elasticity of substitution is higher between capital equipment and unskilled labour than between capital equipment and skilled labour. The productivity of workers increases during employment as a result of on-the-job-learning (OJL) within and across skill types...
Our interest in skilled and unskilled labour markets is motivated by empirical evidence on the importance of the differences between these two labour markets regarding both wage and employment rates. In particular, wage in equality between skilled and unskilled labour has increased in recent decades to its highest levels in a century. Employment differs significantly between the two sectors with unskilled employment more volatile than skilled although both closely tracking cyclical output.
The model is calibrated to match steady-state aggregate and sectoral labour market data in the U.S. We find that the model does a good job of matching the cyclical properties of sectoral la our markets. Consistent with the data, the model predicts that the volatility of unskilled employment is about twice as large as that of skilled employment, and a measure of the skill premium whose volatility is less than output and its correlation with output is around zero. Moreover, our paper predicts an employment volatility which ranges around 70-80% of that in the data, whereas in the canonical models this ratio is typically only about 25%.
We then use the model to evaluate the effects of temporary fiscal interventions in terms of increasing vacancy subsidies or cutting income taxes. The results suggest that vacancy subsidies for skilled and unskilled jobs can lead to fiscal multipliers on output which are greater than unity with OJL but less than unity when there is no OJL. These large multipliers under OJL are determined by the crowding-in of private investment, which follows the increases in employment and labour productivity. Without OJL, the labour productivity channel is absent and causes the multipliers to fall to about 0.6. In contrast, the positive output effects from cutting skilled and unskilled income taxes are close to zero. This is because income taxes affect employment indirectly, by working via the distorted labour market, i.e. Nash bargaining, which implies that part of the benefits of increasing employment are lost. We finally find that the effects of both skilled and unskilled vacancy subsidies do not depend on whether debt or distorting taxes are used to finance them. This finding suggests that this type of intervention may be particularly useful under the debt ceilings that many governments now face in the wake of the financial crisis.
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