Labour Market Policies and Unemployment in the Presence of Search & Matching Frictions

  • George Emeka Onwordi

    Student thesis: Doctoral ThesisDoctor of Philosophy


    This thesis consists of three theoretical chapters, all related to the response of unemployment to shocks and the role of active and passive labour market policies. Throughout the thesis, unemployment is assumed to evolve as a result of the uncoordinated nature of the labour market along the lines outlined in the Diamond-Mortensen-Pissarides equilibrium search and matching model.

    Chapter 2 examines the effects of employment policies on vacancy creation and allocation decisions of firms and unemployment across workers with different skills. We develop a partial equilibrium model with heterogeneous high- and low-tech jobs and with skilled and unskilled workers, which we motivate by the stark evidence on the incidence of cross-skill employment (which crowds out unskilled workers, e.g. evidence for the US, the UK and the EU put these at 58%, 32%, and 35%, respectively). We show that certain employment protection policies could, in fact, lead to a reduction in job creation and might alter the allocation of vacancies across low- and high-tech job type. We find that: (i) skilled workers benefit while unskilled workers experience high jobless rate; (ii) policy effects differ when they are skill-specific; (ii) stricter policies can have more severe consequences; and (iv) vacancy creation subsidy can play a key role in reducing unemployment across worker type as well as alleviating the cross-skill crowding out of jobs. Against conventional wisdom, we demonstrate that severance compensation can have a ‘real’ effect on job creation decision, provided there is some degree of strictness in its enforcement.

    Motivated by the extensive use of fiscal stimulus policies and labour market reforms during the last economic crisis, in Chapter 3 we study the implications of labour market regulations in driving the sensitivity of an economy to fiscal spending shocks, in a Dynamic Stochastic General Equilibrium (DSGE) model with job search frictions. We demonstrate that less rigidity in the labour market reduces the impact of fiscal demand shock on job creation and employment, both at extensive and intensive margins, whereas higher rigidity amplifies it. We also establish that the extent to which government spending promotes economic activity, job creation and employment depends on the degree of substitutability between private and public consumption. Higher substitutability dampens economic activity and reduces the sizes of output and employment multipliers. Labour market-oriented fiscal spending is found to be the most potent policy instruments for promoting employment – especially in the presence of high labour market rigidities.

    Finally, in Chapter 4, we study how openness to international trade and capital mobility and their interactions with labour market policies affect the behaviour of an economy, in particular with respect to its unemployment level. We show that the degree of openness to international capital flow is crucial for understanding the response of unemployment to different shocks. In isolation, by raising the incentive to invest, a reduction in capital mobility barriers leads to lower unemployment, both in the long-run and the dynamic short-run. With limited restrictions to capital movement, unemployment responds faster and with greater magnitude to a domestic productivity shock, and this is further enhanced the more the economy is open to international trade. A striking finding of this study is that while a higher degree of capital mobility enhances the adjustment of unemployment in response to a domestic productivity shock, it dampens its adjustment to a foreign demand shock. By contrast, higher openness to international trade enhances the adjustment effects of both shocks on unemployment. Finally, we find that heterogeneity in the welfare state systems in the EU can generate substantial differentials in the adjustment of unemployment to various shocks.
    Date of Award2016
    Original languageEnglish
    SponsorsScottish Institute for Research in Economics & Royal Economic Society
    SupervisorHassan Molana (Supervisor) & Yu-Fu Chen (Supervisor)


    • Labour market policies
    • Unemployment
    • Search and matching frictions

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