Matching, adverse selection and labour market flows in a (post)transition setting: the case of Croatia

This article studies employment prospects of different types of job seekers in Croatia by upgrading the model of adverse selection with firing costs. Based on Labour Force Survey data for 1996–2006 we find the existence of adverse selection in the Croatian labour market. Reservation wage, as the main determinant of firing costs in the model, positively affects the probability of changing job for employed job seekers, while it has a negative impact on the probability of ‘switching’ for unemployed job seekers. However, if reservation wage is treated as endogenous in the model, instrumental variable estimation shows that its effect on the probability of ‘switching’ becomes positive and significant only for the unemployed group. This is explained by the effect of educational attainment, which serves as the ‘instrument’ and obviously works as an efficient signal for workers' productivity among the unemployed. Nevertheless, the effect of reservation wage on employment probabilities for both groups is declining over time, especially after the legislative reform in 2004, indicating a lower impact of firing costs. Finally, the hypothesis on self-discrimination of the unemployed receiving unemployment benefits is tested, showing a positive impact of unemployment benefits on the reservation wage and a negative one on the probability of finding a job.