The Low‐Pay No‐Pay Cycle: Are There Systematic Differences across Demographic Groups?

Date01 December 2015
Publication Date01 December 2015
AuthorRoger Wilkins,Rosanna Scutella,Yin King Fok
©2014 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd.
doi: 10.1111/obes.12084
The Low-Pay No-Pay Cycle:Are There Systematic
Differences across Demographic Groups?*
Yin King Fok, Rosanna Scutella† and Roger Wilkins
Melbourne Institute of Applied Economic and Social Research, Faculty of Business and
Economics, The University of Melbourne, Melbourne, Vic. 3010, Australia (e-mails:,,
We investigate transitions between unemployment, low-paid employment and higher-paid
employment using dynamic panel data methods applied to household panel data. We find
state dependence in both unemployment and low-paid employment and evidence of a low-
pay no-pay cycle.However, wealso find significant differences in effects across population
subgroups. Typically, the young and better-educated face lower penalties from unemploy-
ment and low-paid employment. Further,low-paid employment is preferable to unemploy-
ment for women regardless of their demographiccharacteristics, but for men who have only
completed secondary schooling, low-paid employment actually decreases the chances of
entering higher-paid employment by more than does unemployment.
I. Introduction
Understanding the relationship between unemployment,low-paid employment and higher-
paid employment is critical to developing effective welfare-to-work policies. Interest gen-
erally centres on whether low-paid employment provides a stepping stone to better jobs
or simply represents an ‘absorbing’ or persistent state – or, even worse, is simply part
of a perpetual cycle of low-paid employment and unemployment/non-employment. The
stepping stone hypothesis hinges on low-paid jobs helping to developemployment-related
skills and thereby improving the capacity of workers to progress into better jobs. Alterna-
tively, low-quality low-paidjobs may be inherently unconducive to skills development and
may, furthermore, tend to be insecure/unstable and possibly temporary in nature, leading
to cycling in and out of employment.1
JEL Classification numbers: J01, J31, J60
*This research was conducted as part of ARC linkage project ‘Job retention and advancement for disadvantaged
jobseekers’ with the Brotherhood of St Laurence (LP0776894).The paper uses the confidentialized unit record file
from the Household, Income and Labour Dynamics in Australia (HILDA) Survey. The HILDAProject was initiated
and is funded by the CommonwealthDepartment of Social Ser vices (DSS) and is managed bythe Melbour ne Institute
of Applied Economic and Social Research (MIAESR). The findings and viewsrepor ted in this paper, however, are
those of the authors and should not be attributed to either DSS or the MIAESR.
1Transitions between unemployment and low-paid employment can also be affected by the availabilityof unem-
ployment benefits and associated incentivesto work. In a country like Australia, where benefits are not related to prior
The low-pay no-pay cycle 873
Authors such as McCormick (1990) and Stewart (2007) go so far as to argue that
low-paid employment has the same deleterious effect on future employment outcomes as
unemployment, as employersuse low-paid employment as a screening device to determine
worker quality, in the same manner as they do with unemployment.If this is the case, it has
quite major implications for the design of welfare-to-work policies. In particular, a ‘work-
first’ strategy will not, on its own, be sufficient to get the unemployed on to a trajectory
towards steady employment in ‘decent’ jobs. While Stewart (2007) indeed finds adverse
effects of low-paid employment for men in the United Kingdom, evidence outside of
the United Kingdom suggests that low-paid employment improves employment prospects
compared to non-employment (Uhlendorff, 2006; Buddelmeyer, Lee andWooden, 2010).
The literature to date has, however, given very little attention to the potential for past
unemployment and low-paid employment to have quite different impacts on people with
different characteristics. For instance, a spell of unemployment may have few adverse
effects on future employment prospects for university-educated people in the prime of
their working life, but have substantial adverse effects for older less-educated workers.
In this paper, we therefore examine whether there are systematic differences in the
interrelated dynamics of unemployment and low-paid employment across demographic
groups. First, we examine whether there is evidence of an overall ‘low-pay no-pay’ cycle
and also, following Stewart, whether low-paid employment offers improved future em-
ployment opportunities over continued unemployment. We then examine whether there
is heterogeneity in effects across different population groups. To answer these questions,
we estimate a simultaneous model of the dynamics between unemployment, low-paid em-
ployment and higher-paid employment onAustralian household panel data. Our approach
accounts for unobserved heterogeneity and for the initial conditions problem that stems
from the inclusion of a lagged dependent variable as a regressor.
Our study has several other distinctive features. First, we expand on the traditional
definition of unemployment, which only includes people actively seeking employment, to
include other jobless groups that are marginallyattached to the labour force. Unemployment
as a concept has important limitations as a measure of labour supply. It requires active
search for employment, thereby eliminating people who would in fact work if employment
was available. Second, we use a definition of low pay that is a function of the legislated
minimum wage, which is arguably more appropriate than a relative earnings measure for
the Australian context.Third, we examine models for men and women separately.Existing
literature has either focused on men only or examined men and women jointly (estimating
a single model). We would argue that employment–unemployment dynamics of women
are as of much interest as those of men and, moreover, the dynamic processes are likely to
be different for men and women.
The paper is structured as follows. Section II reviews the previous literature on the
dynamics of low-paid employment and unemployment. Section III describes the methods
used to capture the dynamic relationship between the three labour force states – unem-
earnings, replacement rates for low-paid jobs are higher than for higher-paid jobs. Over the time period examined in
this paper however, net replacement rates for the initial phase of unemployment were quite lowby OECD standards
(OECD, 2010). The unemployment benefit is also subject to activityrequirements with a ‘well-functioning compli-
ance and sanctions regime’ (p. 128). Therefore, while it is likely that some observed persistence in unemployment
may be explained by the availability of unemployment benefits in Australia it is unlikely to have a large effect on
transitions between low-paid employmentand unemployment.
©2014 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd

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