Unemployment traps: Do financial disincentives matter?

This paper analyses the importance of financial disincentives for workers in Denmark. Based on a panel survey which is merged to a number of administrative registers it is possible to calculate precise measures of the economic incentives for labour-force participants between employment in a full time job and being on unemployment insurance benefits and considering also the fixed costs of work. The results indicate large disincentive effects for some groups, especially low paid women. In 1996, 6 per cent of Danish men and 13 per cent of the women had a lower disposable net income if working in a full-time job compared to being on unemployment benefits. The effect of these financial disincentives is analysed in simple reduced form models of on-the-job search, unemployed search behaviour, unemployment risk, and transitions out of the labour force. We find that the net compensation rate in unemployment has a significant impact on women's propensity to leave the labour force, on measures of search intensity, on the risk of being hit by unemployment, and on one of our flexibility measures, i .e. the maximum acceptable commuting time to a job. The net compensation rate has no impact on the willingness to move to another place to get a job. However, here we find a significant impact from measures related to job attitude. We end the paper reporting the results from including attitude variables along with economic variables. We find a number of significant effects from attitude variables. However, the main conclusion is that economic incentives dominate the present analysis of unemployment traps.