Talent Discovery, Layoff Risk and Unemployment Insurance

Abstract

In talent-intensive jobs, workers' performance reveals their quality. This enhances productivity and wages, but also increases layoff risk. If workers cannot resign from their jobs, firms can insure them via severance pay. If instead workers can resign, private insurance cannot be provided, and more risk-averse workers will choose less informative jobs. This lowers expected productivity and wages. Public unemployment insurance corrects this inefficiency, enhancing employment in talent-sensitive industries and investment in education by employees. The prediction that the generosity of unemployment insurance is positively correlated with the share of workers in talent-sensitive industries is consistent with international and U.S. evidence. JEL: D61, D62, D83, I26, J24, J65.

Risk Sharing Within the Firm: A Primer

“…The next two subsections present two settings in which the uninsurability of human capital risk triggers two different responses by workers to hinder talent discovery. Section 6.1 presents a simplified version of the model in Pagano and Picariello (2017), where workers prevent learning by taking jobs that are not informative about their talent. This results in lower average productivity, as untalented workers are retained, but public unemployment insurance can eliminate this inefficiency and establish efficient risk sharing.…”

“…As in Pagano and Picariello (2017), consider a setting where labor income risk does not originate from firm-level shocks but from the unknown quality of employees. Specifically, suppose they may be either talented or untalented, with probabilities p and 1 p − respectively, and before hiring their quality is unknown to everyone, including themselves.…”

“…This market failure, in turn, triggers an inefficiency in production, as workers will seek jobs in safe firms, where there is no learning about workers' quality and the untalented are kept on. However, as noted by Pagano and Picariello (2017), this "double inefficiency" in risk sharing and in talent allocation can be avoided via public unemployment insurance. If each worker retained pays a contribution (1 ) H py − and each one dismissed receives an unemployment benefit H py , all employees in risky firms will receive a risk-free income stream H py .…”