Training and Search during Unemployment

This paper incorporates training in the design of unemployment policies. Human capital falls upon displacement and continuously depreciates during unemployment. While training counters the decrease in human capital, it also affects the willingness of the unemployed to search. I characterize the optimal insurance contract when participation to training programs with varying intensity during the unemployment spell can be enforced by the social planner. The analysis provides three sets of results. First, the introduction of training qualifies previous results on the optimal consumption path during unemployment; the optimal path may be constant rather than downward-sloping for the short-term unemployed and downward-sloping rather than constant for the long-term unemployed. Second, the optimal contract never stops encouraging the long-term unemployed to leave unemployment. The imposed training programs make their human capital converge to a unique, positive level. Third, the practice of targeting training programs towards long-term unemployed is optimal only if the fall in human capital upon displacement is small relative to the depreciation rate during unemployment. Moreover, numerical simulations suggest that the welfare gains from introducing training programs are substantial, but only if the fall in human capital upon displacement is relatively large.