Less educated workers suffer a disproportionate share of unemployment, which many economists and policy-makers have therefore proposed to reduce through increased training programmes. The secular trend towards a higher proportion of educated workers has been accompanied, however, by rises in both the relative unemployment rate of the unskilled and its aggregate level. In Discussion Paper No. 921, Research Fellow Gilles Saint-Paul develops a model of malfunctioning labour markets, in which a rise in the proportion of skilled workers can lead to further deterioration of the unskilled's employment prospects and possibly increase aggregate unemployment, which may be self-reinforcing if the net returns to education (taking into account the likelihood of being unemployed) increase with the proportion of skilled workers. High- and low-education equilibria therefore coexist: in the first, the unskilled's high probability of being unemployed generates high returns to education; in the second, the converse applies. `Workers' are ex ante worse off under the high-education equilibrium, while `capitalists' are better off.

In this model, if skilled and unskilled workers are perfect substitutes in production, a rise in the proportion of the former reduces the marginal product of both types of labour and hence both skilled and unskilled wages. If real wage rigidity prevents the unskilled wage from falling far enough, unskilled unemployment may rise sufficiently to increase the net returns to education and hence the incentives to acquire it; the economy will eventually reach another equilibrium. Increasing returns are more likely if the real wage is more responsive to low rates of unemployment within any segment of the labour market, which is both plausible and characteristic of many existing models of wage formation. Saint-Paul notes that these results cast doubt on the view that education and training provide panacea for growth and employment. While the unskilled are certainly more exposed to unemployment than the skilled, this does not imply that shifting from the low- to the high-skill equilibrium will raise employment or indeed output, and workers may even find themselves worse off.

Unemployment and Increasing Returns to Human Capital
Gilles Saint-Paul

Discussion Paper No. 921, February 1994 (IM)