DP9344 | Horizontal skills mismatch in the labor market: Protecting the past vs. protecting the future

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This paper shows how high bargaining power for firms and search costs in the labor market can impede a switch towards new, more competitive economic activities. This is because search costs drive the quality of the horizontal matching between worker types and the old and new sectors of the economy. The high bargaining power of firms pushes wages down, so that small search costs are enough for young workers or workers with new skills to give up looking for jobs in the new sector. Employers end up giving up offering these jobs as well. Politically popular labor policies protecting a dominating old sector and old workers, fail to address the mismatches and increase unemployment. Simply switching support to the new sector may cut jobs for the older workers and thus create other welfare losses. A more effective modernization policy, for both jobs and products, is to link wages to output.