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Persistence of unemployment

does competition between employed and unemployed job applicants matter?

Stefan Eriksson

Uppsala, Department of Economics, Uppsala University, 2002, 154 s. ; (Economic studies / Department of Economics, Uppsala University 69) ; ISBN 91-87268-76-0

This thesis consists of four self-contained essays

Essay 1 (with Nils Gottfries) investigates why unemployment is so persistent in Europe. We formulate an efficiency wage model with on-the-job search where wages depend on turnover and employers may use information on whether the searching worker is employed or unemployed as a hiring criterion. We show theoretically that ranking of job applicants by employment status affects both the level and the persistence of unemployment and numerically that these effects may be substantial. More prevalent ranking in Europe compared to the US (because of more rigid wage structures etc.) could potentially help to explain the high and persistent unemployment in Europe.

Essay 2 investigates the consequences of skill loss as a result of unemployment in an efficiency wage model with turnover costs and on-the-job search. Firms are unable to differentiate wages and therefore prefer to hire employed searchers or unemployed workers who have not lost human capital. It is shown that if some fundamental factor in the economy changes, this will result in a lengthy adjustment process with substantial long run unemployment effects. Moreover, the model is capable of generating persistence but the amount depends on the duration of the shock itself.

Essay 3 considers the optimal hiring strategy of a firm that is unable to observe the productive abilities of all its applicants. Whom the firm considers as hireable, will depend crucially on the extent to which the firm can use its wage setting to mirror productivity differences. However, when setting its wages the firm has to consider other factors as well, e.g. turnover, that may make it optimal not to set wages that fully reflect productivity differences. Instead, it may be optimal to avoid hiring workers that have certain characteristics; i.e. to use a discriminatory hiring strategy. In the paper it is shown that discrimination based on employment status is an equilibrium hiring strategy even when the firm is free to set different wages for workers with different expected productivities. It is also shown that if all firms use such hiring procedures this will have strong implications for the aggregate economy and welfare.

Essay 4 (with Jonas Lagerström) investigates whether being unemployed per se reduces the probability to get contacted by a firm. We use Swedish data from the Applicant Database (Sökandebanken), which contains both employed and unemployed workers who search for a new job. The key advantage with this dataset is that we have access to the same information as firms have when they choose whom to contact. Our results indicate that an unemployed worker faces a lower probability to get contacted by a firm and receives fewer contacts over the sample period. These findings support the claim that firms view employment status as an important signal for productivity.