Measurement of labor quality growth caused by unobservable characteristics

The standard economy-wide indices of labor quality (or human capital) largely ignore the role of unobservable worker characteristics. In this paper, we develop a methodology for identifying the contri- butions of both observable and unobservable worker characteristics in the presence of the incidental parameter problem. Based on data for Switzerland over the period 1991-2006, we find that a large part of growth in labor quality is caused by shifts in the distribution of un- observable characteristics. The contributions to growth attributed to education and age are corrected downwards, if unobservable worker characteristics are taken into account. Yet the standard indices of la- bor quality appear to be robust to this extension.