Labour Supply in a High Unemployment Economy: The Appropriateness of ILO Guidelines
Although in the estimations above we assumed that hd>0 (the desired hours of work are greater than zero) for the unemployed, a significant number of working age population are inactive. Included among them are persons not searching because they do not expect to find jobs (usually referred to as the discouraged workers), although they would like to work if jobs were available. Assuming that engaging in job search by the non-employed workers is endogenous to labour market conditions, we expect that in high unemployment economies the discouragement effect may be more pronounced.
In our analysis above, using the Riinvest HLFS data, we utilised the ILO guidelines of active job search criteria to divide the non-employed individuals into the unemployed and inactive (as shown in Figure A1). In this section, we assess the appropriateness of this approach in cases when unemployment is high. We run some statistical tests to consider if the discouraged workers are different from the rest of the inactive population and discuss the implications for the labour supply in Kosova if they are included in the active labour force. Finally, we investigate the determinants of engaging in job search.
To facilitate the comparison of unemployment rates and other labour market indicators over time and across countries, the ILO has adopted guidelines that classify the working age population into employed (E), unemployed (U) and inactive (N). These guidelines have been adopted by most countries. While the classification of E is relatively straightforward, there are controversies regarding the division
of the non-employed into U and N. In the ILO, a non-working person is considered as U if he/she is: (i) not working, (ii) currently available for work, and (iii) seeking work. Otherwise he/she is considered as N. The implicit assumption in this framework is that these non-employed individuals voluntarily decide not to search.
In the supply and demand model of competitive labour market equilibrium, the interaction between workers looking for the best job opportunities and employers attempting to maximise profits equalises the value of marginal product of labour across firms. The model considers job search as a rational behaviour since it leads to finding the job offer with the highest rewards. This is also desirable from the social point of view, because it contributes to achieving the allocative efficiency of resources. The decision to search is affected by search costs, the distribution of expected wage offers, the probability of finding another job offer, unemployment benefits etc. However, in a high unemployment economy (such as Kosova), the probability of locating a job offer is low. Due to the search costs involved, some of the unemployed may stop searching and are considered as inactive by the ILO guidelines (i.e. the discouraged workers as explained by the discouraged-worker hypothesis). Kingdom and Knight argue, there are two main reasons why workers stop searching. The first is based on the so-called ‘taste for unemployment’ argument whereby non-working members of the household receive high intra-household transfers. The second reason relates to the search costs, which affect the poor individuals that cannot afford to continue searching in which case excluding them from the labour force underestimates the true extent of unemployment.
However, in practice it is difficult to clearly distinguish between personal and labour market related reasons for being a discouraged worker. The inclusion of the discouraged workers within the labour force is based on the argument that these workers are behaviourally similar to the unemployed (e.g. they tend to enter employment during an economic upturn). On the other side, discouraged workers show a similar (weak) degree of labour force attachment as other groups of individuals in the inactive population and hence the argument not to include them in the labour force. On balance, as our discussion below suggests, whether they should be included among the labour force or not remains an empirical question.
Even though the discouraged workers are likely to exist in any economy, in developing countries with slack labour markets the incidence of discouraged workers is likely to be higher. Consequently, excluding them from the labour force affects significantly the estimated unemployment and inactivity rates and consequently may have important implications for policy. Reflecting this, in a limited number of countries both narrow (ILO definition) and broad (with the discouraged workers considered as unemployed) unemployment rates have been estimated.