The importance of human capital in development and economic growth is now well understood. Many economists view the low stock of human capital of many underdeveloped countries as a serious obstacle to growth and also as a factor that reduces the return to the human capital investment of other agents. In Discussion Paper No. 1026, Research Affiliate Daron Acemoglu shows that search in the labour market has important effects on accumulation decisions. In a labour market characterized by search, employment contracts are naturally incomplete and this creates a wedge between the rates of return and marginal products of both human and physical capital. As a result, when workers invest more in their human capital, they increase the rate of return on physical capital. Provided that these factors are complements in the production function, this will increase the desired level of investment for firms. Then, because physical capital is not being paid its marginal product, the rate of return on all human capital goes up.

The paper also shows that a multiplicity of equilibria can arise from these interactions in the presence of technology choices: more productive technology will often be profitable to adopt when other firms are doing so but not otherwise. This also implies that the factor distribution of income has an important impact on growth. Finally, the paper derives new links between unemployment and human capital accumulation and shows that when technology choice is made endogenous, search introduces a negative wage formation externality which may lead to excessively fast diffusion of new technologies. High-unemployment and low-growth equilibrium can co-exist with an equilibrium that has low unemployment and a high growth rate.

Search in the Labour Market, Incomplete Contracts and Growth
Daron Acemoglu

Discussion Paper No. 1026, September 1994 (IM/HR)