Unemployment and Inactivity Traps in the Czech Republic: Incentive Effects of Policies

We investigate to what extent high net replacement rates between non-work and work household income may distort work incentives. Using a microsimulation model, we find that net replacement rates are particularly high for households with a working partner and children. While net replacement rates decreased moderately between 1996 and 2006 as wages rose faster than social benefits, the incidence of unemployment traps remains high. In particular, about a third of all employed individuals have a low incentive to avoid short spells of unemployment with the unemployment benefits provided, while unemployment traps are also widespread among the unemployed. The incidence of unemployment traps increased further in 2007 despite a reform of benefits. In particular, housing benefit, which was overhauled to reflect housing costs, increases net replacement rates, distorting work incentives particularly among households with children. In addition, the rise in parental allowance may lock eligible individuals in non-employment, increasing the loss of human capital among non-working parents. This is particularly important for single parents, who face the highest specific unemployment rate, and also long unemployment spells among all household types. While the link between net replacement rates and labour market stocks and flows is not straightforward across household types, further research should focus on the labour market behaviour of particular household types.