Hysteresis & the Unemployment Problem

Summers and Blanchard have a paper on Hysteresis in Europe in the 1980s in which they discuss three main potential causes of hysteresis, which is a very high dependence of current employment on past unemployment. The three causes are (1) physical capital, (2) human capital, and (3) insider outsider models of wage determination.

They largely dismiss (1) and don’t think (2) is sufficient to explain what they see in the data, but it’s interesting to read their description of how (2) works in light of today’s persistently elevated level of unemployment.

The second and perhaps more important mechanism works through human capital, broadly defined.  […] Essentially, the human capital argument holds that workers who are unemployed lose the opportunity to maintain and update their skills by working. Particularly for the long term unemployed, the atrophy of skills may combine with the disaffection from the labor force associated with the inability to find a job to reduce the effective supply of labor. Early retirement may be a semi-irreversable decision. More generally, if for incentive or human capital reasons employers prefer workers with long horizons, it may be very difficult for middle-aged workers to find new jobs. A final point is that in a high-unemployment environment, it will be difficult for reliable and able workers to signal their quality by holding jobs and being promoted. The resulting inefficiencies in sorting workers may reduce the overall demand for labor.

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About ozidar

Graduate student at UC Berkeley, studying public finance & labor economics. https://sites.google.com/site/omzidar/
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One Response to Hysteresis & the Unemployment Problem

  1. Pingback: Historical Hysteresis: Adverse Shocks vs Structural Problems | owenzidar

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