RDP 2002-07: An Exploration of Marginal Attachment to the Australian Labour Market 2. Literature Review

2.1 Defining Marginal Attachment and Discouraged Workers

Using the official ABS definitions (ABS 2000), a person is classified as being unemployed if they are not employed, want to work, are actively searching for work and are available to start work. Persons not in the labour force who want to work are classified as being marginally attached to the labour force if they are actively looking for work but not available to start work in the reference week, or are not actively looking for work but are available to start work within four weeks.

An important subset of the marginally attached group are discouraged workers who are defined by the International Labour Organisation (ILO) as persons who want a job and are currently available for work but have given up actively searching for work because they believe they cannot find work (Hussmanns, Mehran and Verma 1990). The main reasons given by discouraged workers for not actively searching include that: the state of the market is so poor that there are few jobs available, an individual's qualifications or skills do not match those required in available jobs, or employers want younger employees. While the official ILO definition excludes people who give personal reasons for not looking for work, the ILO recognises that it may be difficult to draw a clear distinction, as respondents may not be able to abstract their personal circumstances from the labour market situation.

There are arguments both for and against treating marginally attached workers as unemployed and therefore as participating in the labour market (Hussmanns et al 1990). The extent to which the marginally attached should be treated the same as the unemployed depends, to a large degree, on the extent to which they re-enter the workforce over time. One argument for their inclusion in the labour force is that such people are willing and, in many cases, available for work. It is also argued that discouraged workers might be expected to behave similarly to the unemployed during an economic recovery and, thus, to be particularly likely to re-enter the core labour force.

The argument against the classification of the marginally attached and discouraged workers as unemployed relates to measurement problems. While unemployment depends on objective criteria, discouragement is a more subjective definition (Finnegan 1981). It should also be recognised that there is a subjective component of what constitutes active job search.

The relative merits of such arguments can only be evaluated in the context of specific studies of how the labour force attachment of marginally attached and discouraged workers compares to that of the unemployed. While there is some international evidence that discouraged workers have no more tendency to re-enter the workforce during periods of economic recovery than others who are not in the labour force, the Australian data have not been empirically tested (Flaim 1984; Hussmanns et al 1990).

2.2 A Brief Introduction to the Literature

The discouraged worker concept has a long history in labour economics. Empirical studies of the relationship between the labour force participation rate and the unemployment rate date back to the 1940s. Woytinsky (1940) developed the ‘additional worker theory’, which suggests that the participation rate should increase during recessions because there would be an influx of ‘fringe’ potential workers into the labour market. This occurs because of their need to supplement family income following unemployment of the ‘breadwinner’.

In contrast, Humphrey (1940) and Long (1958) argued that unemployed workers become discouraged during a recession due to the diminished likelihood of finding employment and consequently exit the job market. This phenomenon was labelled the ‘discouraged worker effect’. This theory suggests that the labour force participation rate should decrease during recessions because looking for work has such a low expected pay-off for these people that they decide spending time at home is more productive than spending time in job search.

McConnell and Brue (1992) argue that the discouraged worker effect should outweigh the additional worker effect because the discouraged worker effect applies to many more households. For example, if the household unemployment rate rises from, say, 6 to 9 per cent, only those 3 per cent or so of all families who now contain an additional unemployed member will be subject to the additional worker effect. On the other hand, worsening labour market conditions may have a discouraging effect upon both the actual and potential labour force participants in all households.

While the pioneering literature into marginal attachment and discouraged workers was largely empirical, it needs to be placed in a theoretical framework to facilitate analysis and interpretation. One suitable framework is the search theoretic framework, which relates individual optimising labour supply behaviour to the macroeconomic cycle, and defines two reservation wages. The first is the labour supply reservation wage. This is the wage rate below which the person would not accept a job. The second is the search reservation wage, below which the person will not search for work, even if they are willing and available to work. If there are search costs, then the search reservation wage will be greater than the labour supply reservation wage. In this framework, a marginally attached worker will be any individual who wishes to work at the current wage, but does not engage in active search because the expected costs of job search outweigh the expected benefits (Blundell, Ham and Meghir 1998).^[1] For these individuals, a fall in the costs of job search or an increase in the probability of success from job search would mean that they would be more likely to start actively searching for employment.

The empirical literature on the relationship between aggregate unemployment and labour force participation rates has emphasised the role of business cycle factors in determining labour demand, and therefore the costs and benefits of searching for work. Local labour market conditions will also affect the level of labour demand and so have a role in explaining the labour market dynamics of the marginally attached. Personal characteristics that affect the demand for an individual's labour, such as skill levels, will be important. The probability of being a discouraged worker or marginally attached will also be affected by any other factors, such as family composition, that influence the utility of non-participation and the costs of the search, which can be considerable and include both the time, monetary and psychological costs of rejection.

2.3 Overview of Empirical Studies

Empirical studies can be classified into two groups: aggregate time series evidence and microeconomic evidence, which is often based on cross-sectional data. Despite McConnell and Brue's (1992) intuitively appealing argument that the discouraged worker effect will dominate the additional worker effect, the empirical analysis of aggregate time series data has been mixed. For example, Benati (2001) concludes that US research is inconclusive. That is, while a number of US studies find that labour force participation rates have no cyclical variation, other studies find that there is either a mild or strong discouraged worker effect. However, the evidence from other countries is more clear with the discouraged worker effect tending to prevail over the additional worker effect (Gregg 1994; Tachibanaki and Sakurai 1991).

The aggregate time series data for Australia also show that there is a strong discouraged worker effect. For example, Lenten finds:

…when Australia heads towards recession, as approximately 100 people become unemployed, approximately 37 additional people exit the workforce in the long-run through discouragement, thus leading to a pronounced understatement of the real unemployment rate. (Lenten 2001, p 16)

Other Australian literature has tended to focus on providing detailed summaries of unemployment, discouragement and other marginal attachment for various socio-demographic groups (Strieker and Sheehan 1981; Wooden 1996). These studies find that the degree of labour force discouragement is generally higher for females than for males, especially women with children under 15 years of age, and for unmarried people than for married. Also, people born in Australia are more easily discouraged than their foreign-born counterparts, as are secondary and tertiary students compared to non-students. By region, it is found that there is a greater incidence of discouraged workers in high unemployment regions.

The main limitation of aggregate time series studies and cross-sectional studies is that it is not possible to understand an individual's labour force dynamics. Few of the existing studies use longitudinal data to investigate whether the labour market dynamics of discouraged workers have more in common with the behaviour of the unemployed than the behaviour of those who do not wish to work. Using US data for the period 1983–86, Martini (1988) finds that the average duration of a completed spell of ‘discouragement’ is short – less than three months – and that 75 per cent of completed spells of discouragement end in a spell of job search or in employment.

The analysis in this paper is most closely related to Jones and Riddell (1999), who use longitudinal data from the Canadian Labour Force Survey to examine the movements of individuals between labour market states. These data allow them to separate marginally attached and discouraged workers from other individuals who are not in the labour force. They find that the dynamic behaviour of the marginally attached is quite different to both the unemployed and the rest of the NILF and consequently that the stated desire to work is an important characteristic.

Footnote

This definition can be extended to the case in which a person does not wish to work in this period but may want to work in the future if their circumstances changed or if wages are higher in future time periods. [1]