February 2020

IZA DP No. 12974: Output Costs of Education and Skill Mismatch

We propose a simple theory of under- and over-employment. Individuals of high type can perform both skilled and unskilled jobs, but only a fraction of low-type workers can perform skilled jobs. People have different non-pecuniary values over these jobs, akin to a Roy model. We calibrate two versions of the model to match moments of 17 OECD economies, considering separately education and skills mismatch. The cost of mismatch is 3% of output on average but varies between -1% to 9% across countries. The key variable that explains the output cost of mismatch is not the percentage of mismatched workers but their wage relative to well-matched workers.