On the Impact of Unemployment Benefits

by Veronique de Rugy

Over at the Money Illusion, the excellent Scott Sumner takes a look at the impact of unemployment benefits on labor supply:

1.  The statistical evidence on UI is overwhelming significant. When the UI benefits maxed out at 26 weeks, there was a spike in the number re-employed right after the benefits ran out. That’s not to say the benefits are necessarily inefficient, if the spike was due to the income effect then UI might actually make the job market more efficient. But it’s hard to dispute the fact that UI insurance does have some effect on labor supply. And that means some effect on employment, as studies show that the effects on unemployment duration even occur in areas with double digit unemployment.

2.  Many Western European countries such as France saw their natural rates of unemployment rise from around 2% in the 1960s to about 10% in the 1980s. We don’t know all the reasons, but the most plausible explanations have to do with various labor market policies. Progressives have NEVER come up with a plausible explanation for this sharp rise in the European natural rate of unemployment. Until they do they have no business calling out conservatives who warn that the same thing could happen here.

3.  Denmark recently found that their four year maximum on UI benefits was distorting the labor market, and cut the maximum duration to 2 years. Denmark is arguably the most progressive, most civic-minded country on Earth. Were they just imagining this problem? Were the policymakers over there hypnotized by Casey Mulligan?

4.  Both liberals and conservatives seem prejudiced against the proletariat, but in slightly different ways. Some conservatives seem to think the unemployed are lazy, not willing to work hard. This outrages liberals, but I find their defense of the unemployed to be just as offensive. They seem to concede that if UI did increase unemployment, then the accusation of “laziness” would be valid. That’s easy to say if you have a nice, cushy, interesting white collar job that pays well

Sumner thinks that casting the debate about how people respond to unemployment benefits in terms of “laziness” is wrong (I agree), and that instead we should think about it in terms of self-interested decision-making. Basically, while some people do react to the incentives provided by unemployment insurance, the important questions are how much of an incentive is it and how many unemployed workers we’re talking about. According to Sumner, the fact that a certain number of people choose unemployment over work because of UI doesn’t matter right now for designing the right policy to reform the system.

I was surprised he didn’t mention the UI reforms in Germany. As my colleague Matt Mitchell noted a few weeks ago, Germany successfully reformed their labor-market laws ten years ago, and these changes could be at the core of the country’s lowest unemployment rate in 20 years. Among other things, the reforms enabled Germans to get “mini-jobs” without a large penalty and made unemployment relatively uncomfortable so that people would look for jobs. These changes are both real and impressive — especially compared with equivalent European countries like France.

Sumner’s post is here; the comment section  is interesting. Here, Tyler Cowen has a set of questions on what the size of the safety net should be. He frames the debate in an interesting way.

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