Stochastic labour market shocks, labour market programmes, and human capital formation: a theoretical and empirical analysis

This paper develops a life-cycle model of labour supply that captures endogenous human capital
formation allowing for individual's heterogeneous responses to stochastic labour market shocks. The
shocks determines conditions in the labour market and sort individuals into three labour market regimes;
employment, unemployment with and unemployment without participation in labour market programmes.
The structural model entails time independent stochastic shocks that have transitory effects on monetary
returns while the effect on human capital formation may be permanent. The permanent effect may justify
the existence of active labour market programmes if these programmes imply non-depreciating human
capital and human capital depreciation is detected for the non-participant unemployed. Using several
years of the Swiss Labour Force Survey (SAKE, 1991 - 2004) the empirical section compares the
dynamic formation of human capital between labour market regimes. The results are consistent with the
assumptions of the structural model and suggest human capital depreciation for unemployment without
programme participation. They further show that labour programmes may act as a buffer to reduce human
capital loss while unemployed.