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Financial frictions and occupational mobility

William Hawkins and Jose Mustre-del-Rio ()

No RWP 12-06, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: An important risk faced by individuals is labor income risk associated with changes in demand for an individual?s selected occupation. This risk reflects uncertainty about future income on the current job. As an example, the declining competitiveness of the U.S. automobile or steel sectors are events that are unanticipated from the perspective of a worker, yet have a strong bearing on future labor income for these workers. One way to limit labor income risk is by switching occupations. This, however, is costly because of retraining costs, forgone earnings, and lost occupational specific experience. Hence, understanding when and which workers switch occupations is a non-trivial question. ; This paper examines the decision process through which individuals switch occupations as a way to limit labor income shocks. From a positive standpoint, understanding why and when individuals switch occupations is crucial for understanding the behavior of labor income. From a normative standpoint, if imperfect financial markets hinder occupational mobility, then there is a clear role for monetary policy to improve economic outcomes ; We quantify the importance of financial frictions for occupational mobility and for economic welfare. We consider a world where financial markets are incomplete, occupations receive shocks, and switching occupations is costly for the aforementioned reasons. In our benchmark model we find that occupational mobility is significantly lower than in a world with complete financial markets. This translates into reduced economic welfare for individuals as they cannot efficiently reallocate across occupations. We then assess the impact of policies aimed at increasing occupational mobility. In a simple example, we find that an across the board subsidy to switching occupations increases mobility but not economic welfare.

Date: 2012
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