Abstract

The relationship between specific skills and the welfare state has been the subject of considerable debate. To help resolve the conflict, we present a general model of preferences over social insurance with endogenous wages and investment in specific skills and a variety of exogenous constraints. Our dynamic model underscores the link between wages, skills and unemployment risks. It shows that skill-specificity is irrelevant for preferences over social insurance when wages adjust for investment costs and unemployment risks. We validate the adjustment mechanism with U.S. data. We then extend the model to show how different conditions, including centralized wage bargaining, capital market imperfections, and taxation, affect skill formation and skill-based preferences for social insurance. Our model provides an analytical framework that can reconcile the disparate empirical findings and demonstrates how they, along with Iversen and Soskice's seminal results, are special cases of the interaction between labor markets and politics.