Unemployment Persistence 1

We estimate dynamic panel data models of unemployment incidence of British men, in order to disentangle the effects of unobserved individual heterogeneity and true state dependence. We also control for the ‘initial conditions’ problem that arises when the start of the observation period does not coincide with the start of the stochastic process generating individuals’ unemployment experiences. Our data set is the new British Household Panel Survey for the period 1991-5. We find strong evidence of state dependence, especially for more mature men (defined as those aged 25 and over in 1991). This finding is consistent with the ‘scarring’ theory of unemployment an individual’s previous unemployment experience has implications for his future labour market experience, perhaps because of depreciation of human capital, or because employers use an individual’s previous labour market history as a screening mechanism, or because unemployed workers are more likely to accept low quality jobs characterised by high rates of job destruction. Our finding of genuine state dependence for adult men suggests that policies reducing short run unemployment incidence will have longer-run effects by reducing the equilibrium or natural rate of unemployment. JEL Classification: C23, C25, J6, J64