The Labour Market Adjustment During the Crisis: The Case of Estonia

At the end of 2007, low unemployment rate characterised the Estonian labour market. However, after Estonia fell into a deep recession at the end of 2008 and with the currency board in place, the labour market has been bearing most of the adjustment. The unemployment rate thus increased to 14 percent by mid 2009, reaching the highest level in the enlarged EU. It is therefore important that labour market reforms include a balanced mix of flexibility, activation and social protection. Accordingly, in July 2009, the new Employment Contract Law came into effect, relaxing employment protection legislation (EPL) while seeking to raise income protection of the unemployed. Utilizing a dynamic search model, this paper analyzes the impact of the main labour market reforms contained in the Law. It finds that deregulating EPL will have a positive impact on the speed of transition, but unambiguous effect on longer term unemployment level. Linking increases in unemployment benefits to participation in job search programmes would improve workers’ incentives to search for jobs as well as the medium term outcomes. JEL Classification: J08, J64, E24, C61, C63.
Keywords: Labour market adjustment; dynamic search model, active policies; crisis, Estonia