Are Specific Skills an Obstacle to Labor Market Adjustment? Theory and an Application to the EU Enlargement

Countries react differently to large labor reallocation shocks. Some minimize the costs by adapting rapidly, while others suffer long periods of costly adjustment, typically high and persistent unemployment and temporary output losses. We argue that the existence of large amounts of specific human capital slows down the transitions and makes them costly. We illustrate this point by building a theoretical framework in which young agents' careers are heavily determined by the type of initial education, and analyze the transition to a new steady-state after a sectoral demand shift. In the absence of mobility, it can take as much as a generation for the economy to absorb the shock. An interesting case study is the European Union enlargement, which led to a modernization of many sectors in Eastern countries and to a fast decline of traditional industries and agriculture. Using labor force data from a large economy with rigid labor markets, Poland, and a small open economy with increased flexibility, Estonia, we document our main claim, namely that specialized education reduces workers' mobility and hence their ability to cope with economic changes. We find that holding a vocational degree is associated with much longer unemployment duration spells, relatively large wage penalties when changing jobs and higher likelihood of leaving activity for elder workers. Quantitative exercises suggest that the over-specialization of the labor force in Poland led to much higher and persistent unemployment compared to Estonia during the period of EU enlargement. Traditional labor market institutions (wage rigidity and employment protection) increased, but to a much lesser extent, the unemployment gap.