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An Equilibrium Theory of Learning, Search and Wages

When workers have incomplete information about their own job-finding process, search outcomes convey valuable information. Differences in search outcomes that may initially be caused by luck can induce different updating of workers beliefs about their own job finding process, which will influence workers search behavior in the future and lead to further differences in their re-employment rates and wages. In this paper, we develop an equilibrium framework to characterize this endogenous heterogeneity generated by learning from search and analyze its interactions with job creation and wage determination.

Our theory provides a novel explanation for why longer unemployment durations are likely to be followed by lower re-employment rates and wages (see Addison and Portugal, 1989), shedding new light on how unemployment can affect workers labor market outcomes and wage determination. It thus complements common human-capital explanations that emphasize that workers skills depreciate during unemployment (Pissarides, 1992), or that unemployment durations may signal differences in labor productivity (Lockwood, 1991). Skill depreciation alone is unlikely to explain why re-employment wages and rates fall significantly over short unemployment durations and for low-skilled as well as high skilled workers.

Labor productivity differences alone do not seem to be sufficient either. For instance, Addison and Portugal (1989) find a strong negative effect of unemployment durations on re-employment rates and wages, even after trying to control for observed and unobserved heterogeneity.

Our broader view of human capital emphasizes a distinction between the workers search ability and their labor productivity, and a distinction between exogenous and endogenous heterogeneity. These distinctions can be useful for devising new empirical strategies to address the difficulty to discriminate between duration dependence in workers'search behavior and the effect of uncontrolled worker heterogeneity (Heckman and Borjas, 1980).

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An Equilibrium Theory of Learning, Search and Wages