1. Matching, adverse selection and labour market flows in (post)transition setting: The case of Croatia
Iva Tomić The Institute of Economics, Zagreb
Polona Domadenik Faculty of Economics, University of Ljubljana
Motivation
to discover the main causes of high inactivity and unemployment rates in Croatia:
employment prospects of different groups of job-seekers in Croatia;
to test the role of labour market institutions on the „willingness to search for a job” for unemployed job-seekers;
to identify a group of active population who may be hurt by implicit discrimination due to underdeveloped labour market;
to address the issue of matching and adverse selection in transitional and post-transitional context.
Analytical framework
upgrade of the adverse selection model with firing costs (Kugler & Saint-Paul, 2004):
main assumptions:
employers perceive labour market status as a signal of job-seekers’ productivity;
when hit by a shock, firms may decide to fire the worker, in which case they have to pay a tax F;
firms make higher profits out of good workers than out of bad ones and, thus, low quality workers are more likely to be dismissed  the firm fires the worker if J(m, η)<-F.
firing costs become endogenous variable in the model, i.e. F=F(w):
where:
an increase in the firing costs decreases the job loss rate more for good workers than for bad workers and, thus, worsens the quality of the unemployed, i.e. :
reservation wage (wr) concept is introduced in order to better capture the process of decision making and subsequent matching.
Data
Croatian Labour Force Survey (LFS) conducted on consecutive years in the period
Based on labour market regulation (legislative changes) we have two sub- periods:
pre-reform, before 2004 with more rigid labour market legislation, and
post-reform, after 2004 with more flexible labour market legislation.
respondents have been grouped into one of three homogeneous statuses:
employment;
unemployment;
inactivity.
where the last two are grouped together in empirical analysis.
Probability to switch (probit model)
probability of ‘switching’ from inactivity or unemployment to employment, or from one employer to another in the period of one year:
where X is a vector of individual characteristics of job seekers; OCC and IND represent vectors of job-seeker’s occupation and industry, respectively; U is unemployment dummy equal 1 for those that were unemployed a year before; ul is local unemployment rate; wr represents reservation wage; and Y is the annual dummy variable that controls for general economic conditions.
job finding rate depends on:
job offer rate (X, OCC, IND, U);
acceptance rate (X, wr);
contact rate (X, ul, Y).
Probability to switch (ivprobit model)
in the original specification of the model the constructed relative reservation wage (wr) is endogenous:
where X=(1,X*’)’, X* is a vector of covariates presumably measured without error, and Z (wr) is a predictor vector subject to measurement errors.
instrumental variable probit estimation :
with instruments:
years of schooling
regionally adjusted industry wage
Marginal effects of different variables on the probability of switch to employment for different types of job-seekers (probit estimation)
Note: * p < 0.1; ** p < 0.05; *** p < Standard errors are in parentheses.
emp – employed job-seeker; unp/inct – unemployed/inactive job-seeker.
Marginal effects of different variables on the probability of switch to employment for different types of job-seekers (ivprobit estimation)
Source: Authors’ calculation based on Croatian Labour Force Survey for the period
probit estimation indicates the existence of adverse selection in the labour market due to high dismissal costs:
via the effect of reservation wage on the unemployed job seekers;
the overall probability to find an employment in a given year is higher for the unemployed/inactive population;
the effect of wr on employment probabilities for both employed and unemployed job seekers is getting lower over time indicating lower impact of wr on firing costs, which points to less stringent labour market regulation that leads to lower firing costs at the firm level.
ivprobit estimation gives different results: the effect of wr on the probability to switch becomes significant and positive only for the unemployed job seekers:
this could be explained by the effect of one of the ‘instruments’ - educational attainment which serves as an important signal of higher productivity individual in the pool of unemployed job seekers.
Willingness to search for a job
elasticity of the reservation wage with respect to unemployment benefits:
elasticity of the hazard rate with respect to unemployment benefits (assuming that the wage offer distribution is Pareto distributed):
Elasticity estimates based on the means of the data
Note: Figures in brackets show the change in reservation wages with respect to unemployment benefits in monetary terms.
Source: Authors’ calculation based on Croatian Labour Force Survey for the period
there is a sign of self-discrimination of the unemployed job seekers:
an increase in benefits by 1 Croatian kuna increases the reservation wage from kunas to 0.55 kunas;
increasing benefits reduces the exit rate, which is consistent with probit model.
23rd annual EALE Conference, Paphos – Cyprus, September 22-24, 2011