RDP 1999-02: Reservation Wages and the Duration of Unemployment 1. Introduction

The average duration of unemployment in Australia has increased significantly since the 1960s. Despite its importance for understanding the rise in Australia's aggregate unemployment rate, there has been relatively little empirical investigation of its causes. To the extent that the Australian literature has addressed this issue, the focus has been on explaining the probability of leaving unemployment rather than on the factors which directly affect unemployment duration. In particular, the role of minimum wages, either as legal minima that influence firm behaviour, or as minimum acceptable wages to job seekers, has not been analysed in depth.

This paper investigates the factors affecting the duration of unemployment using data on individual Australian job seekers. These data, which come from the Survey of Employment and Unemployment Patterns (SEUP), allow us to assess the influence of a comprehensive array of personal characteristics. Importantly, the data set provides job seekers' responses concerning their minimum acceptable (or reservation) wage. The reservation wage is a central feature of basic job-search theory, and its availability allows us to specify an empirical model closely tied to theory. Although previous Australian studies have investigated unemployment duration using data on individuals, the reservation wage has only been included in these studies in an ad hoc manner, to the extent that it has been considered directly at all.

We find that the reservation wage does not appear to affect the duration of unemployment. The binding constraint for job seekers is more likely to be that they receive very few job offers. Descriptive evidence suggests that one reason for this may be that minimum wages are pricing some job seekers out of the market. However, more research is required to properly understand the role of minimum wages. Non-wage aspects of employment, such as the type of occupation, also appear to have a role to play in explaining job seeker behaviour.

The rest of the paper is organised as follows: in Section 2 we briefly review current evidence regarding which factors affect unemployment duration in Australia. This also provides an opportunity to motivate the approach taken in this paper. In Section 3 we discuss the data we use and consider descriptive evidence for the role played in job-search behaviour by the reservation wage. We derive an empirical model of unemployment duration from job-search theory in Section 4, and discuss the practical issues of estimating the empirical model in Section 5. Section 6 presents and discusses the results and Section 7 concludes.