Accumulation of Human Capital, Labor Market Hysteresis, and the Business Cycle

Characteristics of business cycles are quite different across developed countries. As Gordon (1982) pointed out, in the United States real wages and the adjustment of working hours are less flexible than in Britain and Japan. Using a business cycle model with microeconomic foundation, this paper provides an economic explanation of these differences across the countries. Cost of on-the-job training plays a crucial role. Since the cost is sunk, once a worker participates, he seldom quits his job. Hence, the training cost causes hysteresis phenomena. In an economy with high training cost, variances of employment and output are relatively small. Instead of the employment level, working hours per employed worker and real wages mainly absorb exogenous shocks. Since a stable employment level and flexible real wages are caused by the high training cost, these characteristics of time series do not necessarily indicate higher efficiency of the economy. Our model can explain some important characters of actual macroeconomic time series, which existing real business cycles models such as those of Kydland and Prescott (1982) and Hansen (1985)cannot explain. Firstly, in our model the correlation between the employment level and output is low in an economy with high training cost. Secondly, labor hoarding phenomena occur in our model and labor productivity is negatively correlated with past output as it is the case in actual economies.