Links between Labor Supply and Unemployment: Theory and Empirics

Abstract

This paper discusses the various causal relations between unemployment and participation to the labor market, notably for groups with elastic labor supply such as women. A flow model of labor market participation is used to describe how various exogenous variations jointly affect unemployment and participation. Empirical tests based on time-series of OECD countries are proposed. Notably, the model is used to determine short-run identification restrictions of a structural VAR. It concludes that, in some countries, fast rising female participation may have had a moderate short and medium run impact on unemployment rates. A variance decomposition exercise indicates that, in Continental Europe, participation is driven in the short run by unemployment shocks, while in the US, it is driven by participation shocks, interpreted as demography or immigration. Unemployment in Europe is driven in the short run by participation shocks while in the US, it is driven by unemployment shocks.