The Specificity of Human Capital Investment under Agent Heterogeneity and Market Frictions: Theory and Empirics

The large difference between the functioning of European and American labor markers has inspired much debate and research. Wasmer (2006) came up with an innovative explanation for this disparity based on asymmetric investment in specific and general human capital between the two economic areas. He developed a model of a labor market with matching frictions and endogenous choice of human capital investment which has never been tested empirically. The present paper expands this model to include individual heterogeneity and brings it to the data. Using international data on over 20 countries from the Luxembourg Income Study (LIS) database which has thus far been largely unexplored in this literature, it finds broad support for the model's findings. Notably, agents seem to prefer investing in specific rather than general skills when market frictions, proxied here by the unemployment rate, are high. This investment is in turn reflected in a significantly increased expected job tenure. These results are robust across countries, education levels, and controls included and should encourage further research into this so far scarcely explored territory.