More on UI and Unemployment

by Josh Barro

Matt Yglesias responds to my post on Unemployment Insurance and links to some evidence that casts further doubt on negative incentive effects from UI.  Particularly, he highlights a model (via Mike Konczal) of UI used in Austria, where workers take their UI benefit as a lump sum, regardless of unemployment duration.

I’m open to the lump sum idea, though I have reservations. But I am significantly less impressed by evidence that Konczal cites (via Harvard’s Raj Chetty) on UI in the United States.

Konczal notes that the generosity of UI has significant effects on duration of unemployment within the United States—but only among people with negative household liquidity. People with positive household liquidity have no apparent significant difference in duration of unemployment as UI generosity changes.

This leads Konczal to conclude that lengthier spells of unemployment are principally a positive, liquidity-related phenomenon: given enough cash to survive, people look longer for a really appropriate job instead of taking the first thing that comes along. Says Konczal: “There’s no reason that people with more savings should feel a work disincentive effect less than those with poor savings.”

Oh really? I can think of a very good reason: unemployment benefits are capped at a fairly low level. In New York State, where I live, the maximum weekly unemployment benefit is $410, equivalent to an annual salary of $21,320. So, the need to forego further UI payments shouldn’t be much of a disincentive for an unemployed lawyer to return to work, but could be significant for an unemployed fast food worker. And there is surely a strong link between a worker’s savings and earnings potential. So, I’d say that the limitation of incentive effects to those with the worst liquidity is entirely consistent with the incentive story about UI benefits and unemployment.

That said, the Austrian evidence (that paying UI as a lump sum leads to longer spells of unemployment rather than shorter ones) does bolster the case that we shouldn’t worry too much about UI providing a disincentive for work. I don’t think it’s a total slam-dunk: some anecdotal stories suggest that laid-off workers may be viewing their severance payments as paycheck replacement rather than rationally treating them as a one-time windfall.

I’m also not inclined to rush out and change UI benefits into a lump sum, as Yglesias proposes. For one thing, a shift to lump sum UI payments would probably require making UI payments more generous overall. That’s because if we moved to a lump sum system but kept the average benefit the same, the workers who need UI the most (the ones with the longest unemployed spells) would see their benefits cut.

So, we’d need to weigh the benefits of a lump sum structure against the cost of a more generous UI system.  Ironically, if the Austrian system’s results show that incentives have little effect on unemployment duration, that actually undermines the case for lump sum payouts. (If Austria shows that there are efficiency benefits from making the unemployed more liquid, that can be achieved by raising the weekly UI benefit; it does not require a lump sum structure.)

Finally, I’d note (as Yglesias does) that even if we moved to lump sum UI payments, it would still make sense to have adjustments for economic conditions, with benefits becoming more generous when the job market is worse and vice-versa. I’d still say those adjustments should be automatic.