The Effect of Wealth on Worker Productivity

Abstract

We propose a theory that analyzes how a workers' asset holdings affect their job productivity. In a labor market with uninsurable risk, workers choose to direct their job search trading off productivity and wages against unemployment risk. Workers with low asset holdings have a precautionary job search motive, they direct their search to low productivity jobs because those offer a low risk at the cost of low productivity and a low wage. Our main theoretical contribution shows that the presence of consumption smoothing can reconcile the directed search model with negative duration-dependence on wages, a robust empirical regularity that the canonical directed search model cannot rationalize. We calibrate the infinite horizon economy and find this mechanism to be quantitatively important. We evaluate a tax financed unemployment insurance (UI) scheme and analyze how it affects welfare. Aggregate welfare is inverted U-shaped in benefits: the insurance effect UI dominates the incentive effects for low levels of benefits and vice versa for high benefits. In addition, when UI increases, total production falls in the economy while worker productivity increases. Finally, we compare a one-off severance payment with per-period benefits and find that per-period benefits generate superior welfare for low levels of benefits and inferior welfare for high benefits.

Keywords: directed search, Duration Dependence, Precautionary Job Search, precautionary savings, Severance pay, sorting, Unemployment insurance, unemployment risk

JEL Classification: C6, E2