Differentiation of Skills and Unemployment: Theoretical Analysis

Introduction

This chapter explores the effects of the negative income tax system in a matching model with an original presentation of interactions between unemployment and job differentiation. Within the context of an economic crisis, unemployment and the deteriorating situation of unskilled workers have become major priorities of the labor market institutions in several developed countries. In response, these nations attempt to reform their public policies such as the income redistribution system.

In the extant literature, authors such as Acemoglu (1999), Gautier (1999), and Albrecht and Vroman (2002) have attempted to endogenize the skill requirements. However, their models focus on vertical differentiation and consider that job productivity (when filled by a skilled worker) does not depend on the state of the labor market. In other words, job differentiation remains essentially exogenous (Mortensen & Pissarides, 1999).

The main contribution and originality of this chapter focuses on two points. First, horizontal jobs differentiation is an endogenous variable which results from the rationale response of firms to the state of the labor market. In other words, it will be shown that firms will be encouraged to offer more adapted jobs to the abilities of skilled workers until unemployment (labor market state) would facilitate their recruitment. Second, this chapter examines this horizontal differentiation by considering there is a skills bias in favor of skilled workers.

A matching model is used here (Pissarides, 2000) in which the horizontal job differentiation is represented as a point of a line segment. Thus, the degree of adequacy is measured by the distance between the two ends of the segment and the point. Intuitively, it is assumed that an increase in this degree of differentiation raises the output of well-suited workers and lowers the output of ill-suited workers. The hiring process between workers and firms is formalized by the usual matching function (Petrongolo & Pissarides, 2001).

This chapter demonstrates that a decrease in the labor market tightness provides firms an incentive to raise the differentiation degree of jobs. In this framework, the effects of a negative income tax system on productivity and unemployment are studied. The result is that an increase in this public policy improves the productivity of skilled workers by making jobs more differentiated and leads to a rise in the unemployment rate. It is important to stress that this chapter is a theoretical formalization which may be complemented by an empirical study to apply it to the Turkish economy. Empirical studies may have the form of simulations based on macroeconomic data on the Turkish labor market. In other words, there is an implicit and indirect link between this theoretical chapter and the Turkish economy. Making this link more direct would require a separate empirical study in another chapter.

The remainder of the chapter is organized as follows. The model is presented in Section 1 and Section 2 discusses the solution of the model and the definition of its equilibrium. Section 3 defines and examines the effects of the negative income tax.