Staying on the Dole

extends the time during which the fruits of retraining are reaped and thus makes an STU spell
for the purpose of retraining attractive. If the retraining effect dominates (reflected by relatively
high e), STU increases with the length of working life; if the human capital degradation effect
dominates (reflected by relatively high d) it decreases.

In any case, however, a prolonged working life reduces LTU when retraining is worthwhile.
Some of the workers from the lower end of the productivity spectrum who previously settled on
a life on the dole find retraining attractive when the fruits of the educational effort are reaped
through a longer working life. This result suggests a strong policy conclusion: Early retirement
cannot be a solution of the unemployment problem (as many central European authorities seem
to have believed in the 80’s and 90’s). Quite the opposite is true according to the model. Another
way of putting this result is that LTU is particularly attractive for older workers (with small
δT ). Furthermore, the derivative of h^A shows that the incentive to stay on the dole permanently
will be strong for older workers when skills erode rapidly and labor income taxes are high.

3.8. Labor Market Tightness. Fluctuations in labor markets are reflected in deviations of
actual wage income from wages paid under ”normal” circumstances, wt = h - λt. We model
labor market tightness as resulting from exogenous events. These can be temporary, perhaps
due to a downturn in the business cycle, or persistent, perhaps due to structural shifts in labor
demand. A contemporaneous and temporary recession is captured by an increase in λ0 , and an
expected recession by an increase in λ_τ . A permanent structural change is modelled by imposing
λ0 = λτ . The corresponding derivatives are

In line with standard intuition, a contemporaneous temporary recession increases STU and
leaves LTU unaffected. The effect on STU is particularly large if unemployment benefits are high
and granted for a long period (δτ is large). The effect is particularly pronounced among older
workers (with low δT). A possibly more surprising prediction of our model is that an expected
future downturn of the economy (i.e. higher λτ) increases LTU. A pessimistic outlook reduces
the incentive to retrain during STU, and some workers of the current STU pool decide against

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