Talent discovery, layoff risk and unemployment insurance

In talent-intensive jobs, workers’ quality is revealed by their performance. This enhances productivity and earnings, but also increases layoff risk. We show that, if firms compete for talent, they cannot insure workers against this risk, so that the more risk-averse workers will choose less quality-revealing jobs. This lowers expected productivity and salaries. Our model predicts that public unemployment insurance corrects this inefficiency, increasing employment in talent sensitive industries. This prediction is consistent with the distribution of U.S. employment across occupations and states. Unemployment insurance dominates legal restrictions on firms’ dismissals, which penalize more talent-sensitive firms and thus depress expected productivity.