Learning-by-doing and unemployment dynamics ☆ Sherif Khalifa ⁎ Department of Economics, Steven Mihaylo College of Business and Economics, California State University, Fullerton, CA 92834, USA abstract article info Article history: Accepted 14 October 2014 Available online xxxx Keywords: Unemployment Skill loss Business cycle Search and matching This paper attempts to assess the impact of skill loss on the persistence of cyclical unemployment. The observa- tions from the Current Population Survey and the Bureau of Labor Statistics suggest a countercyclical total unem- ployment rate that exhibits high persistence. A framework that features search frictions is developed. Households choose search intensities, and firms create vacancies. Workers accumulate skills through past work experience, or a process of learning-by-doing. This paper extends the learning-by-doing framework to consider endogenous skill loss by the unemployed, or a process of loss-of-learning-by-not-doing. An adverse aggregate technological shock induces workers to reduce their search intensity and firms to reduce their creation of vacancies. As unemployment increases, workers lose their accumulated skills. The skill obsolescence causes a decline in the future marginal pro- ductivity of workers. The decline in productivity causes a persistence in the cyclical downturn, and a delay in the recovery of the economy. This allows the model to capture the observed unemployment persistence. © 2014 Elsevier B.V. All rights reserved. 1. Introduction The aftermath of the financial crisis and the cyclical downturn that ensued led to an unprecedented length of unemployment durations. Elsby et al. (2011) showed that continued labor market weakness after the crisis led to the highest level of long term unemployment in the postwar period. The persistence of unemployment spells after an economic contraction, and the delay in the economic recovery, has been the focus of several studies. This paper attempts to assess the impact of skill loss and obsoles- cence on the persistence of unemployment over the business cycle. The evidence for unemployment persistence is well documented in pre- vious studies. This paper uses aggregated data from the Current Popula- tion Survey, and aggregate data from the Bureau of Labor Statistics, to identify the cyclical pattern of unemployment. The observations confirm the previous findings of a countercyclical unemployment that exhibits high persistence over the business cycle. The paper also develops a model to identify the underlying market interactions that are critical in generating the observed behavior. En- dogenous skill acquisition and loss are introduced, in a framework of learning-by-doing. These interactions are captured in a dynamic sto- chastic general equilibrium model that features search frictions. In this framework, the unemployed choose their search intensity for occupa- tions and firms create vacancies. A standard matching function matches searchers with occupations. Workers accumulate skills through past work experience, or a process of learning-by-doing, similar to the one introduced by Chang et al. (2002). In their work, learning-by-doing is found to provide an important propagation mechanism in real business cycle models. Their framework, however, did not consider equilibrium unemployment. This paper extends their analysis to consider skill loss by the unemployed, or loss-of-learning-by-not-doing. The extension al- lows the paper to succeed in capturing the observed unemployment persistence. An adverse aggregate technological shock induces workers to reduce their search intensity and firms to reduce their creation of va- cancies. As unemployment increases, workers lose their accumulated skills. The skill obsolescence causes a decline in the future marginal pro- ductivity of workers. The decline in productivity causes a persistence in the cyclical downturn, and a delay in the recovery of the economy. This allows the model to capture the observed unemployment persistence. This paper adopts a different approach compared to previous studies that attempted to explain the persistence of unemployment. Some stud- ies considered the aspect of skill loss. For instance, Pissarides (1992) shows that when unemployed workers lose some of their skills, they be- come less attractive to firms. Thus, firms create less vacancies. The mar- ket becomes thin because job seekers have less skills. The thin market leads to more job shortage which in turn perpetuates the thinness. Ac- cordingly, the effect of the shock persists. Ljunqvist and Sargent (1998) formulate a model in which workers' skills depreciate during unemployment spells. After a shock, generous unemployment compen- sation hinders the process of restructuring the economy. The unem- ployed lack the incentives to quickly accept new jobs in which skills will have to be accumulated. Consequently, there can be a lengthy Economic Modelling 44 (2015) 180–187 ☆ I thank Thomas Lubik, Louis Maccini, Michael Krause, and the participants in the Eastern Economic Association Annual Conference 2013, the 18th International Conference on Computing in Economics and Finance 2013, the 3rd International Symposium in Computational Economics and Finance 2014, the 77th International Atlantic Economic Conference 2014, and the seminar series at California State University, Los Angeles 2014. Remaining errors are my own. ⁎ Tel.: +1 657 278 3756. E-mail address: skhalifa@fullerton.edu. http://dx.doi.org/10.1016/j.econmod.2014.10.020 0264-9993/© 2014 Elsevier B.V. All rights reserved. Contents lists available at ScienceDirect Economic Modelling journal homepage: www.elsevier.com/locate/ecmod