Do Jobless Benefits Discourage People From Taking Jobs During a Recession?

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Unemployment benefits provide a small amount of help to a number of people who desperately need it. But some economists have gone too far by claiming that unemployment insurance is stimulating the economy.

Unemployment insurance is jointly administered and financed by the federal and state governments, offering funds to “covered” people who lost their jobs and have as yet been unable to find and start a new job. The program has been around for decades, but this recession has created an especially large group of laid-off workers who, despite an extensive search, genuinely cannot find another job.

With no new job in sight, a large group of people are under considerable personal and financial stress. In recognition of these facts, the “stimulus” law of 2009 extended the eligibility period for unemployment benefits, and provided additional funds for the program.

Before this recession, most economists probably thought that some amount of unemployment benefits were just and compassionate, and offered a sense of security even to people who were lucky enough to retain their jobs, despite the fact that the program would raise unemployment rates and reduce both employment and economic output.

In other words, unemployment benefits shrink the economy to some degree, but shrinking the economy a bit may be a price worth paying.

Unemployment benefits were thought to reduce employment and output because, by definition, working people were ineligible for the benefits. In particular, an unemployed person who finds and starts a new job, or returns to working at his previous job, is supposed to give up his unemployment benefits. Economists had found that a large fraction of unemployed people delay going back to work solely because the unemployment insurance program was paying them for not working.

Fewer people working means a lower employment rate, and less output because unemployed people are not yet contributing to production.

The recession has seen a number of economists ignore prior findings on unemployment insurance, at least as long as this recession continues. For example, in evaluating the stimulus law economists at the nonpartisan Congressional Budget Office assumed that the law would raise gross domestic product, and took no account of the fact that the unemployment insurance and other provisions of the stimulus law give people incentives to work less.

Paul Krugman recently summarized the incentives-do-not-matter point of view in his blog (see also a leading labor economist at Harvard, quoted here):

Everyone agrees that really generous unemployment benefits, by reducing the incentive to seek jobs, can raise the [normal unemployment rate]… But in case you haven’t noticed … What’s limiting employment now is lack of demand for the things workers produce. Their incentives to seek work are, for now, irrelevant. [emphasis added]

I have not seen any evidence to support this claim that, in essence, the laws of economics are suspended as long as a recession continues. Rather, the available evidence suggests the opposite.

One feature of the unemployment insurance program is that it specifies an exhaustion date: a person stops receiving benefits when he or she starts working again, or reaches the exhaustion date (often a fixed number of weeks after being laid off), whichever comes first.

In the past, economists observed that a large fraction of unemployed people suddenly started working again within a week or so of their exhaustion date, despite having been without work for so many weeks prior: evidence that the benefits themselves were sustaining unemployment.

If the Congressional Budget Office, Professor Krugman and others were correct, this pattern would be absent during a recession, because the demand just isn’t there, and demand will not miraculously appear merely because of the arrival of the benefit exhaustion date.

A study published by two labor economists, Štepan Jurajda and Frederick J. Tannery, looked at employment histories for unemployment insurance recipients in Pittsburgh in the early 1980s. Unemployment rates got quite high in Pittsburgh in those days, reaching 16 percent at one point, and staying over 10 percent for two and a half years.

The chart below summarizes their findings for Pittsburgh.

The chart displays the fraction of persons (in Pittsburgh) receiving unemployment benefits who began working again, as a function of the number of weeks until their unemployment benefits were scheduled to be exhausted. For example, a “hazard” value of “0.04″ for week “-14″ means that, among unemployed persons with 14 weeks remaining until their benefit exhaustion date, 4 percent of them either began working a new job or returned to their previous job.

Very few people started working during the two to three weeks prior to the exhaustion of their unemployment benefits (weeks “-3″ and “-2″ in the chart). But almost 30 percent started work just a week later (19 percent started a new job, 10 percent returned to a previous job).

“Demand” may have been lacking in Pittsburgh in the early 1980s, but that did not stop unemployed people from responding to the work incentives presented to them by the unemployment insurance program (economists also looked for this pattern during a Swedish recession, and found it there too).

Unemployment insurance is only a small part of the reason why the labor market has so far failed to restore employment to pre-recession levels. But unemployment insurance is not free: It results in less employment and less output, not more. The real question is whether, and for how long, this price is worth paying to continue a just and compassionate program.