Switching costs and sectoral adjustments in general equilibrium with uninsured risk

Abstract

Consider a two-sector economy subject to recurring technological shocks. These affect earnings in the two sectors differently, creating incentives for workers to switch occupation. Switching costs are sunk. Individuals are risk-averse and cannot diversify their income risk. We characterize the rational expectations equilibrium of the economy and illustrate the extent to which uncertainty and switching costs increase labor immobility. The resulting equilibrium is not even second-best optimal. Even a government that cannot transfer income to achieve insurance can improve matters by speeding up the reallocation of labor across sectors, because that reduces relative price variability. Journal of Economic Literature Classification Numbers: D52, D62, J62. © 1994 by Academic Press, Inc.