Human Capital Dynamics and the U.S. Labor Market

The high U.S. unemployment rate after the Great Recession is usually considered to be a result of changes in factors influencing either the demand side or the supply side of the labor market. However, no matter what factors have caused the changes in the unemployment rate, these factors should have influenced workers' and firms' decisions. Therefore, it is important to take into account workers' endogenous responses to changes in various factors when seeking to understand how these factors affect the unemployment rate. To address this issue, we estimate a Mortensen-Pissarides style of labor-market matching model with endogenous separation decisions and stochastic changes in workers' human capital. We study how agents' endogenous choices vary with changes in the exogenous shocks and changes in labor-market policy in the context of human capital dynamics. We reach four main findings. First, once workers have accounted for and are able to optimally respond to possible human capital loss, the unemployment rate in an economy with human capital loss during unemployment will not be higher than in an economy with no human capital loss. The reason is that the increase in the unemployment rate led by human capital loss is more than offset by workers' endogenous responses to prevent them from being unemployed. Second, human capital accumulation on the job is more important than human capital loss during unemployment for both the unemployment rate and output. Third, workers' endogenous separation rates will decline when job-finding rates fall. Fourth, taking into account the endogenous responses, unemployment insurance extensions contributed 0.5 percentage point to the increase in the aggregate unemployment rate in the 2008–12 period.