Unobserved Heterogeneity and Skill Loss in a Structural Model of Duration Dependence

In this paper, I use an equilibrium search model of the labor market to quantify the importance of two classic explanations for why the job-finding rate strongly falls with unemployment duration: (i) unobserved worker heterogeneity and (ii) loss of skills. In the model, unobserved heterogeneity has a large impact on job-finding rates but not on reemployment wages. Wages depend almost exclusively on workers' skill levels. I use the available causal estimates of the effects of unemployment duration on callback rates and reemployment wages to calibrate the model parameters for unobserved heterogeneity and skill loss. Quantitative analysis of the model reveals that unobserved heterogeneity accounts for a little more than two thirds of total duration dependence in unemployment, while skill loss for the remaining part. Next, the effects of training and subsidized employment programs on duration dependence are examined through the lens of the model. Subsidized employment raises job-finding rates for all workers but helps short-term more than long-term unemployed workers. Training raises the job-finding rates of the long-term unemployed but lowers job-finding rates for workers with short unemployment spells. The interaction of unobserved heterogeneity with skill loss due to endogenous vacancy creation is crucial for these results. (Copyright: Elsevier)