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Is There Room for Compromise on Unemployment Insurance?

by Matt Mitchell on December 1, 2010

in Economic Policy

Last night the Senate allowed unemployment insurance benefits to lapse for those Americans who have been receiving such benefits for 99 weeks or more. What will happen to the unemployment rate? Let’s look at it in the short-run and in the long-run.

Short Run:  

I would argue that in the short-run, it is unclear. On the one hand, Keynesians believe that unemployment insurance is one of the more effective forms of fiscal stimulus: by putting money in the hands of those who are likely to spend it, the Keynesian multiplier can work its magic, rippling throughout the economy leaving prosperity in its wake. That is, unless the estimates of the Keynesian multiplier are widely off-target. And there are some reasons to believe they are.

But even if we grant the Keynesians this argument, we have to consider the countervailing evidence. There are numerous studies that show that extensions in potential benefit duration are correlated with longer unemployment spells. Moreover, other studies show that the probability of finding employment rises just prior to the lapse of benefits.

Of course, aside from the macroeconomic effects, we have to consider the fact that unemployment checks help people. And maybe we should be willing to harm the economy at-large for the sake of helping those who are out of work.

Long Run:

The long run story is clearer. From 2000 to 2004, the U.S. unemployment rate averaged about half that of France, Germany, Italy and Spain.

 

In 2004, among the unemployed, the U.S. fraction that was unemployed for more than a year was about one-fourth that of other nations.

 

So compared with other nations, we have an extremely healthy labor market and we all benefit from this. As I have noted before, numerous studies attribute our relatively low long-term unemployment rate to our more competitive labor market. Compared with other nations, U.S. labor taxes are lower, labor regulations are less-burdensome, and unemployment insurance benefits are less-generous. Because of this, employers are more likely to hire and employees are more likely to accept offers. This is an incredible advantage. And we should not take it for granted.

Reconciling the Short with the Long Run:

So in the short run, unemployment insurance may help the economy while it undoubtedly helps those who find themselves unemployed. But how do we achieve this short-term aim without jeopardizing the competitive labor markets that have benefitted all Americans?

Perhaps there is room for compromise. One option may be to agree to extend benefits now in exchange for reform of the system. As Eileen has noted, we would do well to consider systems such as that of Chile. They have two systems that work side-by-side: one is a social insurance system that is similar to our own unemployment insurance program; the other is an Unemployment Insurance Savings Account (UISA) program in which workers are required to save a fraction of their earnings in a personal account. Workers have an incentive to get back to work quickly because whatever amount they leave in the account becomes theirs when they retire. Former Clinton Administration economist and Nobel laureate Joseph Stiglitz has made a similar proposal for the U.S. that would integrate unemployment insurance with retirement insurance. Maybe now is the time to give it a thought?

  • Econophile

    I have already subscribed to this theory … but what is the impact during a severe recession or depression such as we are having now. It’s one thing to measure the effect of unemployment insurance during relatively prosperous times, where a job seeking may not be incentivized to look for a job. But when there is massive economic dislocation and job destruction, would the same rationale apply?

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