Replacement rates and labour market behaviour

This paper studies how the replacement rate, defined as the ratio of disposable income when unemployed to expected disposable income if beginning to work, affects individuals’ transition rate from unemployment. Linked register data, representing a local Finnish labour market in 1996, are analysed with piece-wise constant exponential hazard models. Results suggest that the effect of the replacement rate and, thus, of “unemployment traps”, is fairly modest. It does not seem to change with time spent unemployed. The impact on the transition rate into employment is lower than on the transition rate out of the labour force. Unemployment insurance recipients are found to be less sensitive to changes in the replacement rate than are unemployment assistance recipients.