Earnings, Education and Fixed Term Contracts

EXPECTED WAGES OF THE UNEMPLOYED

Nearly two thirds of people who are unemployed one year and in a job the next end up with a wage below their ‘reservation wage’ – the lowest wage at which they say they are willing to work. This suggests that employment rather than a ‘suitable’ wage is ultimately what is important to jobseekers.

What’s more, an individual who has an expected wage lower than their predicted wage increases the probability of subsequent employment by up to 9%. Conversely, individuals who have unrealistic expectations about their labour market prospects are less likely to leave unemployment.

These findings – by Sarah Brown and Karl Taylor, presented to the Royal Economic Society’s 2009 Annual Conference at the University of Surrey – suggest that job search activity has an important moderating influence on the probability that the reservation wage exceeds the predicted market wage.

So searching for jobs is an important way for the unemployed to gather information about the labour market and form realistic wage expectations. Policies aimed at encouraging job search activity may serve to inform jobseekers about prevailing wages and, hence, may lead to more realistic labour market aspirations and expectations.

According to economic theory, the reservation wage, the lowest wage at which an individual is willing to work, plays an important role in the decision-making of the unemployed. To leave unemployment, the unemployed must receive not just any offer of employment but a job offer where the wage is greater than or equal to the reservation wage.

Economic theory predicts that the higher are reservation wages (the ‘choosier’ an individual is), the less likely it is that they will find a ‘suitable’ job offer and exit unemployment. It is apparent that some unemployed individuals may have unrealistic expectations about the wage that they are likely to receive in the labour market.

The researchers analyse the implications of holding such aspirations. Using data from 1996 to 2005, covering 6,202 individuals, they explore how realistic reservation wages are relative to the wages prevailing in the economy. They compare individuals’ reservation wages with their ‘predicted’ market wages, which they base on their individual characteristics such as gender, age, educational attainment and labour market experience.

In the sample, 63.2% of unemployed individuals have a reservation wage that lies within plus or minus 3% of the predicted market wage, suggesting that the majority of the unemployed are well informed about their labour market prospects. Men are more likely to report a reservation wage below their predicted market wage and active job search also increases the likelihood of having a reservation wage below the predicted wage.

The researchers trace individuals and their subsequent labour market experiences over time to explore whether unrealistic wage aspirations influence subsequent employment outcomes and wages. Out of the sample of individuals who are unemployed at a given time period, 22.4% are either employed or self-employed in the following year.

Of these individuals, 62.5% end up with a wage that is actually below their reservation wage, suggesting that employment rather than a ‘suitable’ wage is ultimately what is important. The study finds that having an expected wage lower than the predicted wage increases the probability of subsequent employment by up to 9%.

To summarise, the study finds that individuals who are unemployed and have a reservation wage that is below their predicted wage have a higher probability of future employment and eventually higher wages. Conversely, those individuals who have unrealistic expectations relating to their labour market prospects are less likely to leave unemployment.

In particular, these findings suggest that job search activity has an important moderating influence on the probability that the reservation wage exceeds the predicted market wage suggesting that searching for jobs serves as an important way for the unemployed to gather information about the labour market and form realistic wage expectations.

Policies aimed at encouraging job search activity may serve to inform job seekers about prevailing wages and, hence, may lead to realistic labour market aspirations and expectations.

‘Reservation Wages, Expected Wages and Labour Market Outcomes: Analysis of Individual Level Panel Data’ by Sarah Brown and Karl Taylor (University of Sheffield)

Professor Karl Taylor Department of Economics University of Sheffield 9 Mappin Street SHEFFIELD S1 4DT

Telephone: +44(0)114 2223420 http://www.shef.ac.uk/economics/staff/ktaylor/index.html