Unemployment and Labor Productivity Co-movement: the Role of Firm Exit

Miroslav Gabrovski and Mario Silva
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Mario Silva: Hong Kong Baptist University

No 202301, Working Papers from University of Hawaii at Manoa, Department of Economics

Abstract: The Diamond-Mortensen-Pissarides model implies a nearly perfect correlation between labor productivity and unemployment/vacancies, yet the relationship in the data is mild. We show that incorporating sunk entry costs and vacancy creation in an otherwise standard setup can reconcile the discrepancy. Sunk costs cause vacancies to be a positively valued, predetermined variable. If the destruction shock is infrequent, then most vacancies were created in the past, and hence the number of vacancies in the market correlate more closely with past than current labor productivity. Provided the destruction shock is calibrated to match either micro-level evidence on product destruction and firm exit rates or commonly used values in the growth literature, the model reproduces the empirically observed mild correlation between productivity and unemployment without breaking the strong negative co-movement between unemployment and vacancies.

Keywords: job destruction; entry costs; unemployment; aggregate fluctuations (search for similar items in EconPapers)
JEL-codes: E24 E32 J63 J64 (search for similar items in EconPapers)
Date: 2023-01
New Economics Papers: this item is included in nep-bec, nep-dge, nep-eff, nep-lab and nep-sbm
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