Modelling labour market dynamics with on-the-job search

A flow model of the Dutch labour market is used to calculate the effects of policy options which aim to enhance employment, especially at the lower end of the labour market. The model distinguishes between good and bad jobs, allows for endogenous wage formation and job creation, and describes the flows between these jobs so that job-to-job mobility and the vacancy chain is made endogenous. In the matching process employed job seekers with bad jobs compete with short-term and long-term unemployed for the filling of vacancies for good jobs. In each period part of the good and bad jobs are destroyed which results in inflow into unemployment. The model explicitly describes the flow of unemployed through the various duration classes of unemployment and it allows for negative duration dependence so that the escape probability from unemployment for long-term unemployed is smaller than for short-term unemployed. The model is used to simulate the effects of external shocks, such as structural productivity shocks. An impulse response analysis using the model is also conducted considering labour market policies which aims especially to enhance employment at the lower end of the labour market. In particular, the effects are analysed of measures subsidising the opening of bad jobs (jobs at the lower end of the labour market) and a rise in the productivity of a bad job as compared to a good job which can be achieved by changes in the tax system.