The Cost of Job Loss

In this paper we develop and quantitatively assess a tractable equilibrium search model of the labour market to analyse the long-term wage costs of a job loss. In our framework, these costs occur due to losses in workers' human capital and firm specific compensation, interruptions to workers' on-the-job search and due to turnover heterogeneity. A key feature is that firms post wage-tenure contracts as an optimal response to their employees' search behaviour and human capital accumulation. We estimate the wage losses due to job separation for young workers in the UK and show that our calibrated model fits the observed patterns very well. We use the model to evaluate the importance of each of the components that affect the cost of job loss. Human capital losses exert a strong negative and permanent effect on future wages. The effects of workers' on-the-job search and firms' tenure contracts, although temporary and smaller in size, are long-lasting. It takes workers around 10 years to recover wages through these channels. Human capital losses play a more important role in explaining the extent and persistence of wage losses among low skilled workers. Among high skilled workers, on-the-job search implies re-employment wages start recovering sooner.