Stochastic labour market shocks, labour market programmes, and human capital formation: a theoretical and empirical analysis

This paper develops a life-cycle model of labour supply that captures endogenous human capital formation allowing for individual’s heterogeneous responses to stochastic labour market shocks. The shocks determines conditions in the labour market and sort individuals into three labour market regimes; employment, unemployment with and unemployment without participation in labour market programmes. The structural model entails time independent stochastic shocks that have transitory effects on monetary returns while the effect on human capital formation may be permanent. The permanent effect may justify the existence of active labour market programmes if these programmes imply non-depreciating human capital and human capital depreciation is detected for the non-participant unemployed. Using several years of the Swiss Labour Force Survey (SAKE, 1991 – 2004) the empirical section compares the dynamic formation of human capital between labour market regimes. The results are consistent with the assumptions of the structural model and suggest human capital depreciation for unemployment without programme participation. They further show that labour programmes may act as a buffer to reduce human capital loss while unemployed.