Using cross-country data, we investigate the determinants of reservation wages and their course over the jobless spell. Higher unemployment benefits lead to higher reservation wages. Further, again consistent with the basic search model, repeated observations on the same individual provide scant evidence of declining reservation wages.Reservation wages, probability of reemployment, unemployment benefits, arrival rate of job offers

John T. Addison

Mário Centeno

Pedro Portugal

English

Research Papers in Economics

Deutsches Institut für 
Wirtschaftsforschung
www.diw.de
N
John T. Addison 
Mário Centeno 
Pedro Portugal
Do Reservation Wages Really Decline? 
Some International Evidence on the  
Determinants of Reservation Wages
85
SOEPpapers
on Multidisciplinary Panel Data Research
Berlin, January 2008SOEPpapers on Multidisciplinary Panel Data Research  
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Contact: Uta Rahmann  |  urahmann@diw.de  Do Reservation Wages Really Decline? 
Some International Evidence on the 
Determinants of Reservation Wages 
 
John T. Addison 
Queen’s University Belfast 
and IZA 
Mário Centeno 
Banco de Portugal 
and Universidade Técnica de Lisboa 
Pedro Portugal 
Banco de Portugal, Universidade Nova de Lisboa 
and IZA 
 
Abstract 
 
Using cross-country data, we investigate the determinants of reservation wages and their 
course over the jobless spell. Higher unemployment benefits lead to higher reservation 
wages. Further, again consistent with the basic search model, repeated observations on the 
same individual provide scant evidence of declining reservation wages. 
 
JEL Classification: J64, J65 
 
Keywords: reservation wages, probability of reemployment, unemployment benefits, 
arrival rate of job offers 
 
Corresponding author: 
John T. Addison 
Management School 
Queen's University Belfast 
Belfast BT7 1NN 
Northern Ireland 
United Kingdom 
E-mail: j.addison@qub.ac.uk   2
I. Introduction 
 
Reservation wages play a key role in search theory, wherein optimal job search implies 
the reservation wage property and the optimal stopping rule. Despite its key role in 
theory, however, most empirical search studies have been conducted in the absence of 
reservation wage data, at best identifying this basic search-theoretic element through 
theoretical and auxiliary restrictions (e.g. Bloemen and Stancanelli, 2001).
 For their 
part, the much sparser group of studies with direct evidence on reservation wages 
(surveyed in Devine and Kiefer, 1991) have largely been based on single survey 
responses, and typically contain little retrospective information about employment or 
income histories. And in neither case is there comparative evidence.  
The present exercise is exploratory. We deploy a unique cross-country data set 
that combines survey information on the lowest wages that unemployed respondents are 
willing to accept with detailed information on their employment and income histories to 
examine three key features of the stationary job search model. First, we examine the 
association between reservation wages and unemployment benefits. Second, we provide 
the first evidence of which we are aware on the role of the arrival rate of job offers in 
elevating reservation wages. Finally, exploiting the longitudinal capacity of our data set, 
we determine whether reservation wages decline over the jobless spell.  
 
II. Reservation Wages: The Associations Suggested by Theory 
Assuming income-maximizing workers, infinite lives, unemployment benefits and jobs 
(once accepted), sampling without recall, wage offers that are independent realizations 
from a known wage offer distribution and received according to a Poisson process with 
parameterδ , the reservation wage rate can be written:  
() (
r
rr
w wb w wF w ) ,
δ
ρ
∞
=+ − ∂ ∫    3
where b is the (constant) amount of unemployment benefits net of any search costs, ρ  
is the discount rate, w is the wage offer, and F(w) is the cumulative wage distribution 
(Mortensen, 1977). Evaluating the integral and rearranging terms gives 
() ( | ) 1 ( )
rr r
w wb E w w w w F w ,
r ρ δ ⎡⎤ ⎡ −= ≥− − ⎣⎦ ⎣ ⎤ ⎦  
which makes more transparent the role of the reservation wage in equating the marginal 
costs and benefits of continued search. 
Familiarly, then, changes in the independent variables affect either the marginal 
costs or benefits of additional search, producing offsetting changes in the reservation 
wage. Specifically, the derivatives of the reservation wage with respect to 
unemployment benefits, the arrival rate of job offers, and the mean of the wage offer 
distribution are all positive, while the derivative of the reservation wage with respect to 
the discount rate is negative.   
   The central assumption of the model is that reservation wages are time invariant 
because the present discounted value of accepting a job offer is continuous and 
increasing in w, and because the present discounted value of unemployed search does 
not depend on any particular offered wage, only the distribution.  
 
III. Data 
Our data are taken from the first six waves of the European Community Household 
Panel (ECHP), 1994-99. The ECHP is a survey based on a standardized questionnaire 
administered annually to a representative panel of households and individuals in 15 
member states and offers detailed information on the respondent's labor market 
experience, inter al. (see, for example, EUROSTAT, 1999).
1 We used data for thirteen 
of the countries: Austria, Belgium, Denmark, Finland, France, Germany, Greece, 
Ireland, Italy, Portugal, Spain, the Netherlands, and the United Kingdom. The excluded   4
countries are Sweden and Luxembourg, where it is not possible to follow individuals 
through time. Data is not available for the entire period for five countries. Specifically, 
Austria and Finland were only added to the panel in 1995 and 1996; the data for 
Germany and the United Kingdom are for the first three waves alone because of missing 
data on reservation wages and job offers, respectively, in subsequent waves; and for the 
Netherlands information on reservation wages was missing for the years 1994 and 1995. 
  For us the key pieces of information contained in the EHCP are reservation 
wages, unemployment duration, and job offer rates. In the EHCP every individual 
actively looking for work is asked two questions pertaining first to desired hours of 
work and second to the minimum income required to work these hours. The actual 
questions are: “Assuming you could find suitable work, how many hours would you 
prefer to work in this new job?” and “What is the minimum net monthly income would 
you accept to work [these number of] hours a week in this new job?” The key 
reservation wage construct used in this paper is an hourly net reservation wage, 
computed as the ratio of desired net monthly income to the optimal number of hours. 
This variable was deflated by the respective national consumer price index, as were all 
other nominal arguments.  
The measure of unemployment duration is strictly length of the jobless spell. For 
those actively seeking employment we know both the month and year of the interview
2 
as well as the date on which the previous job was lost. The difference in months is a 
measure of joblessness since it may include intervals of inactivity.  
Finally, as far as the measure of job offers is concerned, the EHCP inquires of 
those seeking employment whether or not they had received a job offer in the previous 
month; specifically, “Have you received any job offer during the past 4 weeks?” We use 
this information on the receipt (and rejection) of job offers to proxy the arrival rate of   5
job offers. According to the model, reservation wages should be increasing in the arrival 
rate of job offers. 
 
IV. Findings 
First consider the determinants of reservation wages. Table 1 focuses on the role of 
unemployment insurance benefits and job offers. Two sets of OLS results are provided 
in the table according to whether the unemployment benefits variable is measured in 
terms of access to benefits or the amount of benefits received. The first (and second) 
column(s) refer to a specification containing an unemployment benefits dummy whereas 
the fourth (and fifth) column(s) refer to results from using the actual log level of 
benefits, each in conjunction with a job offers dummy variable indicating whether or 
not the unemployed individual received any offer of employment in the preceding four 
weeks. Each equation also includes a gender dummy, five time dummies, three 
schooling, and four age dummies.  
(Table 1 near here) 
It can be seen that the coefficient estimate for the unemployment benefits 
dummy is positive and well determined for five countries in the sample. For these 
countries - Denmark, the Netherlands, Greece, Portugal, and Spain - the effect on 
reservation wages of access to benefits is quite strong. For its part, the impact of having 
received a job offer is typically positive as one would anticipate - although this has not 
been demonstrated before - and in six cases is statistically significant. When benefits are 
expressed in monthly values, their influence is statistically significant in six cases 
(albeit not necessarily for the same countries). In this case, however, the elasticities are 
typically small. The principal exception is the United Kingdom where a 10 percent   6
increase in benefit levels elevates reservation wages by 4 percent. Now the effect of job 
offers is much attenuated.  
We next exploit the longitudinal capacity of our dataset to informally inquire 
into the course of reservation wages over jobless duration. To this end, the log hourly 
reservation wage is regressed on the log of elapsed jobless duration for an unbalanced 
panel of unemployed workers. This procedure should be thought of as a strictly 
descriptive exercise because of potential simultaneity. That is to say, reservation wages 
influence duration with certainty, but they may themselves also be influenced by 
duration.  
(Table 2 near here) 
Abstracting from simultaneity issues, Table 2 presents fixed and random effects 
specifications of the reservation wage equation, where the latter account for cross-
section variation over the sample period. For the fixed effects specification in the 
second column of the table – which provides a meaningful control for individual 
heterogeneity – the coefficient estimates for jobless duration are statistically significant 
for just one country in the sample: Spain. And even here the coefficient estimate is very 
small and is only marginally significant. There is slightly greater evidence of a negative 
association between duration and reservation wages from the random effects 
specification, where we observe well-determined negative associations for Austria, 
Portugal, and (again) Spain. That said, the more important point is that reservation 
wages seem to be stationary for the large majority of countries, consistent with the basic 
search model if not with the early literature surveyed in Devine and Kiefer (1991).  
 
 
   7
V. Conclusions 
In this paper we have exploited a cross-country dataset – the European Community 
Household Panel (ECHP) – to examine directly (some aspects of) the role of reservation 
wages in the job search model. This is something of a new departure insofar as 
reservation wages are typically identified indirectly through theoretical and auxiliary 
restrictions. It is only something of a new departure, however, because other studies 
have also looked at direct evidence on reservation wages in individual countries. Our 
treatment differs from that sub-literature not simply in its cross-country basis but also 
with respect to its findings. 
We have seen that both receipt and higher levels of unemployment insurance 
benefits translate into higher reservation wages, even if some of the point estimates are 
not statistically significant and the computed elasticities are quite small.  The muted 
nature of the latter might indicate that there is not enough variation of replacement rates 
within countries. We have also uncovered for the first time the positive impact of the 
arrival rate of job offers on reservation wages.  
Finally, again consistent with the basic model, we report that there is scant 
evidence of a decline in reservation wages with longer joblessness (see also Prasad, 
2003). Indeed, the reservation wage appears stationary. The fact that reservation wages 
appear to be constant is interesting in itself, and may explain why unemployment rates 
are higher in Europe. Long (and in some cases near-lifetime) maximum duration of 
benefits may lie at the root of the problem.   
 
 
 
   8
Endnotes 
1. In 1994 for example some 60,500 such households, or a little over 130,000 adults 
aged 16 years and above, were interviewed. 
 
2. Other than for Germany, where we assume it to be October in each year. 
 
3. We exclude those individuals who reported receiving an offer and who also 
responded in the affirmative to a question in the survey indicating that they had 
accepted this offer. As a practical matter, however, this exclusion did not materially 
alter the results reported in Table 1. 
 
4. If, however, reservation wages are constant, the endogeneity problem is no longer an 
issue. 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   9
References 
 
Bloemen, Hans and Elena Stancanelli (2001). “Individual Wealth, Reservation Wages, 
and Transitions into Employment.” Journal of Labor Economics 19 (April): 400-439. 
 
Devine, Theresa J., and Nicholas M. Kiefer (1991). Empirical Labor Economics – The 
Search Approach. New York and Oxford: Oxford University Press. 
 
EUROSTAT, 1999. European Community Household Panel. Longitudinal Users’ 
Database. Waves 1, 2 and 3. Manual. Luxembourg: EUROSTAT. 
 
Mortensen, Dale T. 1977. “Unemployment Insurance and Job Search Decisions.” 
Industrial and Labor Relations Review 30 (July): 505-517. 
 
Prasad, Eswar (2003). “What Determines the Reservation Wages of Unemployed 
Workers? New Evidence from German Micro Data.” IZA Discussion Paper No. 694, 
June.   10 
       
Table 1 The Determinants of  Reservation Wages: The Effect of Unemployment Insurance Benefits and Job Offers 
    
   
  Full sample  Recipient sample 
          
   
            
 
  Unemployment benefits (dummy)  Job offer (dummy) Sample  size Unemployment benefits (log of amount)  Job offer (dummy)  Sample size 
Country                   
Germany  0.028  0.072**  862          
  (0.024)  (0.035)             
Denmark             
             
           
             
           
           
           
           
             
           
           
0.110*** 0.041 1124 0.056 0.031 645
  (0.033)  (0.029)     (0.039)  (0.041)    
The Netherlands  0.078***  -0.004  787  0.090***  -0.020  158 
  (0.026)  (0.040)     (0.033)  (0.087)    
Belgium -0.035 0.017 1090 0.070*** 0.012 847
  (0.024)  (0.026)     (0.017)  (0.030)    
France 0.013 0.026**  3947 0.125*** 0.001 1598
  (0.008)  (0.012)     (0.010)  (0.020)    
United Kingdom  0.056  -0.070  934  0.391***  -0.254  169 
(0.032) (0.068) (0.157) (0.229)
Ireland -0.008 0.124***  1751 0.170*** 0.240** 214
  (0.018)  (0.035)     (0.050)  (0.100)    
Italy -0.004 0.014  6689 0.035 0.184 130
  (0.023)  (0.021)     (0.025)  (0.132)    
Greece 0.033** 0.063*  3387 0.022 0.026 301
  (0.014)  (0.033)     (0.044)  (0.111)    
Spain 0.090*** 0.038**  6975 0.191*** 0.062 955
  (0.009)  (0.016)     (0.026)  (0.038)    
Portugal 0.039** 0.115**  2051 0.280*** 0.088
  (0.015)  (0.047)     (0.035)  (0.157)    
Austria 0.060 0.047  514 0.140 -0.025 158
  (0.063)  (0.065)     (0.176)  (0.124)    
Finland 0.017 -0.002  1582 0.035 -0.024 842
  (0.054)  (0.080)     (0.023)  (0.097)    
                    
Standard errors in parentheses           
 ***, **, and * denote statistical significance at the .01, .05, and .10 levels         
Note: The regressions include a gender dummy and 3 schooling, 4 age, and 5 time dummies.      
   11
 
Table 2 Estimates of the Impact of (Log) Duration on Reservation Wages Using Longitudinal Data 
      
                Specification  Sample size  
      
  Random effects  Fixed effects   
Country          
      
Germany -0.007  0.019  613 
 (0.011)  (0.018)   
Denmark -0.002  0.018  1303 
 (0.007)  (0.013)   
The Netherlands  -0.014  0.018  421 
 (0.011)  (0.030)   
Belgium 0.000  0.001  837 
 (0.008)  (0.015)   
France -0.004  0.001  2085 
 (0.005)  (0.009)   
United Kingdom  0.006  -0.039  839 
 (0.010)  (0.033)   
Ireland -0.008  -0.015  1583 
 (0.137)  (0.010)   
Italy -0.005  -0.004  4814 
 (0.004)  (0.008)   
Greece -0.013  -0.016  1855 
 (0.006)  (0.012)   
Spain -0.008***  -0.009*  5861 
 (0.003)  (0.005)   
Portugal -0.011*  0.000  1639 
 (0.006)  (0.009)   
Austria -0.028**  -0.008  621 
 (0.014)  (0.059)   
Finland -0.003  -0.001  1683 
 (0.006)  (0.008)   
           
Standard errors in parentheses     
 ***, **, and * denote statistical significance at the .01, .05, and .10 levels   
Note: The regressions include a gender dummy and 3 schooling, 4 age, and 5 time dummies. 
 

Empirical Labor Economics – The Search Approach. New York and Oxford:

European Community Household Panel. Longitudinal Users’ Database.

Individual Wealth, Reservation Wages, and Transitions into

Unemployment Insurance and Job Search Decisions.”

What Determines the Reservation Wages of Unemployed Workers? New Evidence from German Micro Data.”

Do Reservation Wages Really Decline?: Some International Evidence on the Determinants of Reservation Wages

http://www.diw.de/documents/publikationen/73/diw_01.c.78586.de/diw_sp0085.pdf

Do Reservation Wages Really Decline?: Some International Evidence on the Determinants of Reservation Wages

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