Labour Market Reforms and Outcomes in Estonia

In this paper we analyse, on the basis of a matching model, the impact of labour market reforms enacted in Estonia over the last few years on the country’s unemployment rate, which increased markedly in the wake of the recent financial and economic crisis. The results suggest that active labour market policies, including linking unemployment benefits to a participation in job search or training programmes, increase incentives for job search or to retrain as well as longer term labor market outcomes. The model also shows that lower minimum wages may incentivise firms to increase hiring while a lower tax wedge on labour would encourage firms to hire and unemployed people to intensify efforts to search for a new job. The stylised facts presented in the paper support the model’s predictions for OECD
countries:

i.) active labour market policies coupled with higher replacement rates and a lower degree of employment protection legislation go hand in hand with the unemployment rate; and

ii.) a higher tax wedge, especially if combined with a higher minimum wage is positively correlated with the unemployment rate.

While not addressed in this paper, the experience of other countries shows that adequate social protection mechanisms would also improve longer term labour outcomes by allowing the unemployed to search for appropriate jobs or retrain for new jobs arising from structural changes in the economy.