RDP 1999-02: Reservation Wages and the Duration of Unemployment 7. Conclusions

The aim of this analysis was to understand the factors which affect the duration of unemployment within the context of the basic job-search model. The analysis differed from much of the previous analysis of this question for the Australian labour market because our data provided information on a wide cross-section of Australian job seekers, and our empirical model was derived directly from job-search theory. It was possible to estimate this model because our data included information about the reservation wage which, despite being the central focus of economic models, is frequently unavailable in survey data. In addition, this paper estimates a model which allows for reservation wages and unemployment duration to be jointly determined, which has not been the focus of past papers.

The results also suggest that although the reservation wage plays a central role in the theory, it is not a significant factor in explaining incomplete unemployment spells. The key binding constraint on gaining employment is the probability of receiving a job offer. One possible explanation for the low job-offer arrival rate is that minimum wages are too high. Evidence presented in Section 3 showed that a significant proportion of job seekers have reservation wages which lie below the minimum wage, although direct comparison is complicated by the system of award wages and age discounts and potential measurement differences. Further evidence in Section 6, however, suggests that minimum wages cannot be the full explanation for why reservation wages are not important determinants of the duration of unemployment.

Job-search theory also suggests that factors which affect the probability of receiving a job offer given the reservation wage should be controlled for. We found that variables which capture the attractiveness of the job seeker to potential employers such as past work experience and educational attainment, and factors which influence the search effectiveness of job seekers such as eligibility for unemployment benefits were important for explaining unemployment duration.

What is clear from this analysis is that the basic job-search model which focuses on reservation wages is not sufficient for explaining the duration of unemployment experienced by different individuals. Future research should aim to understand the impact of institutions such as minimum and award wages on the demand for labour, how active the unemployed are in applying for jobs, and the importance of non-wage characteristics on job offers. This will involve developing empirical models which jointly consider firms' decisions to offer jobs, and individuals' decisions to accept or reject them.