Public Policy and Human Capital Accumulation in an Endogenously Growing Economy with Labor-Market Frictions

Abstract: We construct a dynamic model with endogenous human capital accumulation in the presence of labor-market frictions to study the effectiveness of education and labor-market policies. We assume that both vacancy creation and job search are costly and that vacancies and job seekers are brought together by a matching technology exhibiting constant returns. Our model departs from the prototypical labor search literature by allowing each firm to create multiple vacancies and each household to choose search intensity endogenously. We find that employment, education effort and output growth rise with an increase in the effectiveness of human capital accumulation or the degree of labor-market matching efficacy, or a decrease in the separation rate or the vacancy creation cost. Our calibration exercises suggest that output growth, employment, vacancy creation, and education and search effort are most responsive to changes in the discretionary education parameter. We also find that, among various education and labor-market policies, a discretionary education subsidy is most effective in promoting education and economic growth but need not be more beneficial in the welfare sense. Moreover, the effects of these public policy programs become larger as the severity of labor-market frictions rises, indicating that a quantitative evaluation of the effectiveness of public policy in a frictionless Walrasian world is expected to be downward biased