Abstract:
This paper argues that factors which impede labour market adjustments
can have first-order impacts on aggregate output and social welfare.
While several studies find that individual workers can face large and
persistent sectoral reallocation costs, this paper demonstrates
that these costs are important at the aggregate level.
I use a search and matching
model to isolate and quantify two factors that contribute to the costly
and time-consuming
adjustment process: search frictions and an inability to transfer
match-specific skills to new
jobs. I apply the model to examine Canada’s sectoral labour adjustment
after a global increase in commodity prices and associated exchange rate appreciation.
These developments
reorganized production to the resource sector and away from
manufacturing. The model
quantitatively captures both the sectoral employment and wage effects
and the response of
unemployment to changes in benefits. The model estimates that the costs
of adjustment
are economically important, accounting for up to three percent of output
during the transition. These costs arise mainly in the first three years after the
shock and are due largely
to non-transferable skills. Finally, the analysis reveals important
policy implications. Because changes to unemployment benefits affect sectors differently, these
changes impact the
economy's sectoral composition and aggregate productivity.