Labor supply shocks and unemployment persistence An empirical analysis of labor market dynamics in The Netherlands

Our small empirical stock-flow model for the Dutch economy, which endogenizes the adjustment dynamics to (un)employment search equilibria, identifies two mechanisms that caused persistence in labor market adjustments: (i) job competition from non-participants, and (ii) asymmetric adjustments to cyclical shocks. At the core of the model is an estimated matching function. Using Dutch flow data for the period 1970-1997 we find that the search effectiveness of individuals on welfare benefits and non-participation is 0.33 respectively 0.05 of the search effectiveness of individuals receiving unemployment insurance. In accordance with actual developments in the reference period, our model simulations show that, when the flow from non-participants into the labor market rises permanently, the unemployment rate rises quickly and stabilizes at a higher level whereas employment continues to rise. Yet, a sensitivity analysis with alternative assumptions on the type of supply shocks and the reaction of labor demand to these shocks indicates that the adjustment dynamics, and hence the degree of persistence, depend much on the search behavior of non-participants. JEL codes: J64, J65, J68, E24, E27