Unemployment versus inactivity: An analysis of the earnings and labor force status of prime age men in France, the UK, and the US at the end of the 20th century

This paper focuses on the differences in earnings and labor force status of low-skilled prime age men in France, the United Kingdom, and the United States at the end of the 20th century, and their relation to the differences in wage dispersion. In the UK and the US, where the bottom of the wage distribution is more dispersed, the inactivity rate (sometimes called the not-in-labor force rate) among low-skilled men exceeds the percentage of the unemployed, whereas in France the opposite is true. This leaves the overall joblessness rate among the low-skilled in France similar to that in the US, and that in the UK about one third higher. I use a partial-equilibrium job search model to provide a supply side explanation of the observed differences. An employed individual's decision whether to work or leave the labor force (be inactive) is affected by his wage. A jobless individual's decision whether to be unemployed and search for a job or be out of labor force is affected by his potential wage. In the UK and the US, where wages are flexible, skill-biased change in labor demand has had a negative effect on the wage of the low-skilled at the bottom of the wage distribution. With lower returns from employment, the low-skilled in the UK and the US are more likely to be inactive. I formulate a four-step econometric procedure to estimate the effect of the wage on the probability of being inactive, the probability of being unemployed, and the probability of being employed. The estimation uses data from the Luxembourg Income Study for France, the UK, and the US in selected years from the period 1994-2001. I find a sizable and significant effect of the wage on inactivity in the UK and the US but none in France. The probability of unemployment as a function of the wage decreases more rapidly in the UK and the US than it does in France. The low-skilled in France face a relatively similar risk of unemployment irrespective of their earning capacity. In the UK and the US, unemployment is concentrated among the low-skilled at the very bottom of the wage distribution. The findings provide evidence against the commonly used argument that wage flexibility improves the employment prospects of individuals at the bottom of the wage distribution.