Different skill levels and firing costs in a matching model with uncertainty: An extension of Mortensen and Pissarides (1994)

A matching model in the line of Mortensen and Pissarides (1994) is augmented with a lowskill labor market and firing costs. It is shown that even with flexible wages unemployment is higher among the low-skilled and increases with skill-biased technological change. The two main reasons are that their jobs have a shorter life expectancy than in the labor market for the skilled, increasing the inflow into unemployment, and that the jobs are less profitable, resulting in a smaller outflow from unemployment. Firing costs increase employment security among existing jobs, but the unskilled are likely to profit less than the skilled, and the availability of new jobs decreases in both sectors. Within the present framework the effect of firing costs on unemployment is ambiguous, but unemployment spells are shown to be longer with higher firing costs. The implications of explicitly introducing business cycles into the model are considered, too.