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This paper tests the hypothesis of a `discouraged worker' effect, whereby local unemployment discourages 16 year-olds from leaving school, among a recent sample of young people in Scotland. The analysis supports the hypothesis: ceteris paribus young people were more likely to stay on at school, the higher the local unemployment rate. Local unemployment was also associated with lower school attainment: its positive direct effect on staying on may have been partly offset by a negative indirect effect mediated by attainment, although the direct effect was stronger and the evidence for the indirect effect was more tentative. The discouraged worker effect applied to staying on at school but not to college, whose courses (in Scotland) tend to be vocationally specific. The discouraged worker effect was similar for girls and boys; it was strongest for 16 year-olds with attainments slightly above the average, who were typically on the margins of the decision to stay on or leave. Staying on tended also to be encouraged by high proportions of local employment in service industries and in higher-level occupations; controlling for these factors increased the observed discouraged worker effect. The paper suggests that the design of most area-based studies of education and the youth labour market is inadequate to explain area differences, given the multi-dimensionality of the effects revealed by the Scottish data. Given the economic `need' for higher levels of educational participation, the paper provides further evidence of the distorted market signals generated by the labour- market context' of education. [ABSTRACT FROM AUTHOR]