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UCL Department of Economics

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Job Market Paper

"Adaptation Costs and the Business Cycle Effects on the Postgraduate Wage Premium"

Abstract

This paper finds that the relative wage between postgraduates and bachelors in the U.S. is counter-cyclical — the postgraduate wage is smoother than the bachelor wage over the business cycle. I argue the reason for this phenomenon is the job-specific adaptation cost due to the relatively low productivity of newly hired workers. Empirical statistics show that job adaptation takes significantly longer for postgraduates. Using an equilibrium search model featuring job adaptation, imperfect monitoring, and aggregate shocks, I show adaptation costs reduce worker's outside options, increase their commitment in the match, and allow firms to better insure them against aggregate shocks. The model shows that adaptation costs alone can explain the differences in the turnover and wage cyclicality between postgraduates and bachelors. The model also shows that postgraduates accept relatively lower starting wages, but the subsequent wage growth is faster. On the other hand, holding risk aversion equal, less educated workers get less wage insurance from firms, hence, increasing the need for social insurance. Then I show that an increase in the unemployment insurance crowds out firm insurance, but less for the low-educated. Non-college workers, who have the least firm insurance, have the highest welfare gain from such a policy.