Household economic incentives, the unemployment trap and the probability of finding a job

This paper considers the sensitivity of the household's disposable income w ith respect to the labour market states and the labour market transitions o f unemployed workers. The paper analyses the following questions: (i) what are the determinants of starting wages? (ii) how many unemployed are in the unemployment trap? (iii) how do household level economic incentives affect the conditional probability of finding a job? The empirical analysis is ba sed on individual panel data covering the years 1987-1993 in Finland, when the unemployment rate rose from about 4 percent to 18 percent. We have esti mated the starting wage equation to calculate the effects of hypothetical r e-employment on the household's disposable income and to evaluate the frequ ency of the unemployment trap. To analyse factors affecting the transition from unemployment to employment in open labour market, we estimate unemploy ment duration using a semi-parametric proportional risk model. The paper sh ows that the impact of the economic incentives, measured by the hypothetica l change in household disposable income, on employment is more important du ring a recession than during a boom.