Seminar tirsdag den 11. februar 2014

Winning versus Losing: How Important are Reservation Wages for Unemployment Duration?

Abstract

Standard job search theory offers clear predictions about how extending unemployment benefit durations affect unemployment. These effects have been confirmed theoretically and empirically in numerous studies. The two main behavioral margins shaping job search behavior are search effort and the reservation wages. However, little is known about the empirical relevance of these two margins in determining job seekers optimal response to changes in unemployment benefit duration. This paper develops a new strategy to analyze the importance of the reservation wage channel for the duration of unemployment. To this end, unemployment exits are decomposed into two exit destinations - exits to wage-improving jobs and exits to wage-declining jobs. According to a standard, non-stationary job search model with endogenous search, unemployment exit hazards to wage-improving jobs are solely determined by search intensity, whereas the exit rate to wage-declining jobs is jointly determined by search intensity and reservation wages. In the empirical analysis, a sharp discontinuity in potential benefit duration from 30 to 39 weeks around the age of 40 is exploited to analyze the effects of prolonged benefits on unemployment duration and survival probabilities. Exits to wage-declining jobs account for around 80 % of the overall unemployment effect. Moreover, analyzing treatment effects on survivor functions highlights that the largest contributions to the overall unemployment effect are observed in the time period from 30 to 39 weeks. These results suggest an important role of the reservation wage channel in shaping job search behavior.

JEL Classification: J64, J65, C41

Keywords: potential benefit duration, unemployment duration, reservation wage, search intensity
 

Contact: Herdis Steingrimsdottir