Staying on the Dole



that they run into a time-inconsistency problem and do not take up the originally planned
retraining. At intermediate education levels, between h
A and h'C, present-biased preferences
have no consequence on unemployment duration (but, of course, on life-time income). At the
lower end of the education spectrum, between
hA and hA, we observe the sad result that workers
who originally planned to re-enter employment after a spell of STU used for retraining find
themselves lacking the willpower to do so. Yet, with failed retraining and human capital erosion,
their productivity is so low to make living on the dole the best available option. Thus, they
end up unintentionally in long-term unemployment. Some of the well-educated are lured into
STU, but will not remain on the dole permanently. It is the low-educated that fall prey to the
unemployment trap and get stuck on the dole permanently.

The preceding discussion indicates the importance of active labor-market policies. If retraining
capabilities are equally distributed across initial education levels, a sufficiently high subsidy of
retraining costs (or a tax allowance) that drives c/(1
θ) below βδT would eliminate the time-
inconsistency problem according to the model. More generally, any commitment device that
enforces retraining would be beneficial for the unemployed (in the sense of increasing his or her
long-run utility) and would reduce short-run and long-run unemployment.

The expression ”unemployment trap” usually refers to a situation where an unemployed person
is unable to increase his income through employment. This applies to all LTU in our model.
What we are concerned with here is the possibility that an agent ends up in LTU against his
best intentions. Note that the discussion above provides a rationale for an unemployment trap
resulting from agents having present-biased preferences but are otherwise rational. Our account
of an unemployment trap is not based on strategic interaction. In contrast, an unemployment
trap may loom, for example, when multiple equilibria arise due to externalities from hiring
restrictions (Saint-Paul 1995), due to discrimination of long-term unemployed (Acemoglu 1995),
or from an interplay of social norms and voting on welfare policies (Lindbeck et al. 1995).

A further explanation for why people end up in unemployment they would have chosen to
avoid ex ante is based on ”forced unemployment”, which can easily be integrated into the
model of section 2. Forced short-term unemployment occurs if a workers optimal choice (given
the prevailing labor market conditions) is to work but the person is for some external reason
inhibited from doing so and is therefore in fact unemployed. Forced short-term unemployment
increases long-term unemployment. The intuition for this result is as follows: Some workers

20



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