Precautionary Mismatch

Abstract

How does wealth affect the extent to which the “right” workers are allocated to the “right” jobs? We study this question using a model with worker and firm heterogeneity, search frictions and incomplete markets. In the model, workers and firms jointly face a trade-off between the speed of match formation and the productivity of a match. As production-maximizing matches are hard to form due to search frictions, workers and firms agree on a range of mutually-acceptable matches. For workers having little wealth while searching for jobs, this trade-off is weighed in favor of speed due to precautionary motive, leading to weaker sorting and thus a higher degree of skill mismatch. We call this phenomenon “precautionary mismatch”. We show that the model’s predictions of the relationships between wealth, search behavior and labor market outcomes are consistent with empirical evidence from NLSY79 and O*NET. To shed light on the role of wealth in affecting labor market allocation and efficiency, we conduct a counterfactual exercise using a financial shock that erases 50% of wealth held by workers. We find that by exacerbating precautionary mismatch, the shock leads to a substantial decrease in productivity, especially for high-skilled workers.