Human capital formation under product market uncertainty

The paper presents a microeconomic model of human capital formation in a local labour market, with heterogeneous workers and firms, when product markets are characterised by price uncertainty. We analyse a setting where firms are hit by demand shocks determining either a good or a bad state. Firms produce for a competitive output market with differing technologies, thus requiring diverse skills. In anticipation of firm behaviour, workers choose between specialising into a certain type of skills, and accumulating general skills. We thus look at the endogenous determination of the level of both horizontally differentiated and general human capital. Our findings suggest that, with equal probability on each shock scenario, a higher output price (booming industry) will raise the return to both general and specific human capital. Labour market size (skill diversification) however, has a differential impact. As the market is enlarged, workers are likely to form more general human capital at the expense of directly productive human capital. We then investigate a specific shock probability structure and find that under more symmetric shocks the incentive to invest in either kind of human capital is weaker. Interpreting the symmetry of shocks as an indicator of the degree of regional industrial specialisation, we infer that, everything else being constant, specialised regions will be less flexible in their response to structural change and also less productive. Bearing in mind the importance of human capital for economic growth, adverse effects on the growth rate of specialised regions may follow.