Demographics and Sectoral Reallocations: A Search Theory with Immobile Workers

We show that a decline in the young share of the population exacerbates sectoral reallocation costs. We develop a three sector, perpetual youth search model with sector-specific human capital and two interconnected frictions: sectoral preferences, which imply that only some workers are mobile across sectors, and a wage bargaining distortion, whereby mobile workers’ outside option of searching in the growing sector dampens the fall in shrinking sector wages, leading to rest unemployment. In our parameterized model, output losses after a sectoral reallocation are significant. As population growth declines from 3 to −1 percent, output losses increase sevenfold, and there are extended periods of high unemployment and low vacancies.