Working Paper: CEPR ID: DP3986
Authors: Pietro Garibaldi; Etienne Wasmer
Abstract: The sustainability of Welfare States requires high employment/high participation to raise the tax base and avoid distortions. To analyse labour market participation decisions in a world with market frictions, we propose and solve a three-state macro model of the labour market. We show that workers' decisions of entering into the labour market and exiting from the labour market are fundamentally different in the presence of frictions: irreversible costs paid by workers at the entry level imply that labour supply is determined by two margins, the entry and the exit margins. On the normative point of view, we show that the existence of two margins alters significantly the conventional effects of payroll taxes and unemployment benefits. On the positive point of view, our model rationalizes the existence of most labour market flows and of 'marginally attached workers'. Furthermore, a calibration improves the usual representations of labour markets.
Keywords: Labour Supply; Search Frictions; Welfare State
JEL Codes: J20; J30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| entry costs (L11) | labor supply (J20) |
| payroll taxes (J32) | employment rates (J68) |
| unemployment benefits (J65) | labor market participation (J29) |