Do Skills Deteriorate During Unemployment and Explain Lower Reemployment Wages?

This study examines whether skills deteriorate during unemployment and contribute to declining reemployment wages. Using panel data from German and American workers, the researchers track cognitive and non-cognitive skills over time. Despite a 16.8% wage loss after six months of unemployment and a 28.1% loss after twelve months, they find no evidence that general skills decline. If anything, skills remain stable or slightly improve. Non-cognitive traits like conscientiousness decline marginally but do not predict earnings. These findings suggest that skill depreciation does not explain wage losses, challenging the assumption that unemployment erodes human capital in a meaningful way.

Full Citation and Link to Article

Cohen, Jonathan, Andrew C. Johnston, and Attila Lindner. "Skill Depreciation during Unemployment: Evidence from Panel Data". AMERICAN ECONOMIC JOURNAL: APPLIED ECONOMICS (FORTHCOMING). https://www.aeaweb.org/articles?id=10.1257/app.20230195&from=f

Extended Summary

Central Research Question

This study investigates whether skills deteriorate during unemployment and whether such skill depreciation explains declining reemployment wages. Many economists and policymakers assume that as unemployment persists, workers lose valuable cognitive and non-cognitive skills, making it harder for them to find jobs and lowering their wages upon reemployment. However, the study challenges this assumption by analyzing panel data from both German and American workers, tracking their skills over time to determine if skill depreciation occurs and whether it accounts for observed declines in reemployment earnings.

Previous Literature

The idea that unemployment leads to skill loss has been widely discussed in economic literature. Previous studies have suggested that long-term unemployment negatively impacts reemployment prospects and wages, potentially due to the loss of general and occupation-specific human capital. Some researchers have found evidence of skill loss, particularly in young workers who experience early-career unemployment shocks that reduce cognitive skills over time. Other studies have linked long-term unemployment to lower reemployment wages but have not directly measured changes in skill levels. Additionally, research on the psychology of unemployment has shown that job loss often leads to declines in life satisfaction, increased depression, and social isolation, factors that could also influence job search success and wage outcomes.

Data

The study utilizes two primary datasets: a panel of German workers and the Health and Retirement Study (HRS) in the United States. The German dataset tracks a representative sample of unemployed individuals from 2007 to 2010, measuring their cognitive and non-cognitive skills at multiple points during their unemployment spell. This dataset is unique because it links survey responses to administrative employment and earnings records, providing a comprehensive picture of labor market outcomes.

The American dataset consists of older workers surveyed in the HRS, a long-term panel study that includes measures of cognitive skills such as memory, mathematical ability, and fine motor skills. The HRS allows researchers to track skill changes before and after unemployment onset, providing a broader perspective on skill dynamics over time. The combination of these two datasets allows for a robust analysis of skill depreciation across different populations and labor market contexts.

Methods

To assess skill changes during unemployment, the researchers employ both within-person and between-group comparisons. In the German data, they compare skill levels at different points in time for the same individuals, controlling for individual fixed effects to isolate the impact of unemployment on skill levels. They also compare the skill trajectories of workers who remained unemployed for extended periods to those who found jobs quickly.

In the American dataset, the researchers use an event-study approach, analyzing how cognitive skills evolve before and after job loss. This method allows them to assess whether skills decline upon entering unemployment and whether those declines persist over time. They also validate the sensitivity of their skill measures by examining skill changes after retirement, an event known to impact cognitive abilities.

To quantify the role of skill changes in wage declines, the researchers construct skill indices that predict earnings based on observed skills. They then estimate the contribution of skill changes to reemployment wage declines, testing whether observed skill dynamics can explain the 16.8% wage loss after six months of unemployment and the 28.1% wage loss after twelve months.

Findings and Size Effects

The study’s findings challenge the conventional wisdom that skills depreciate significantly during unemployment. Despite substantial declines in reemployment wages, the researchers find no evidence that general cognitive skills—such as math ability, memory, and verbal fluency—deteriorate during unemployment. If anything, cognitive skills appear stable or slightly improve over time.

Non-cognitive traits such as conscientiousness, patience, and social trust show minor declines during unemployment, but these changes are small and do not predict earnings in the sample. Moreover, the researchers rule out skill-mediated wage declines of more than 3% after six months and 1% after twelve months, meaning that skill changes explain at most 28% of the observed wage loss after six months and only 6% after twelve months.

In contrast to the stability of skills, the study finds significant declines in life satisfaction among the unemployed. Indicators of depression, loneliness, and dissatisfaction rise sharply following job loss, reinforcing previous research on the psychological consequences of unemployment. These findings suggest that while unemployment does not erode general human capital, it has substantial nonpecuniary costs that could affect job search behavior and long-term well-being.

Conclusion

This research provides strong evidence that skill depreciation is not the primary driver of declining reemployment wages. While long-term unemployment is associated with substantial wage losses, these losses cannot be attributed to declines in general cognitive or non-cognitive skills. Instead, other factors—such as employer stigma, occupational mismatch, or unobserved heterogeneity in worker-employer matches—are likely responsible for worsening reemployment outcomes over time.

These findings have important policy implications. Many employment programs focus on skill training as a way to improve job prospects for the unemployed. However, if general skills do not decline during unemployment, such programs may not effectively address the core challenges faced by job seekers. Instead, policies aimed at reducing unemployment stigma, facilitating faster job matching, or providing psychological support to the unemployed may be more effective in improving long-term employment outcomes.

Overall, this study challenges a key assumption in labor economics and provides new insights into the true costs of unemployment. While unemployment significantly affects wages and well-being, the findings suggest that the loss of general human capital is not a major factor in these declines. Future research could explore the role of occupation-specific skills in reemployment outcomes, as well as the impact of different job-search strategies on long-term earnings recovery.