Unemployment Insurance and Unemployment

Quick finance thought exercise: Let’s say I’m going to buy 100,000 shares of a stock. Leaving C-3P0, Hal-9000, skynet and all the other flash-trading supercomputers that would have an orgy front-running this large market order out of it for a minute, we expect the stock price to rise rationally. More demand for the stock, price has to rise. It may rise, say, 20%, depending on market factors.

Now let’s say instead I just buy 1 share. What happens? Price has to rise; it won’t go down, and I can show you all the equations that say it has to rise. However it is going to “rise” a hundredth of a penny. The rise as a result of this action is negligible and indistinguishable from zero.

So there is a lot of debate this past week as to what the effect is of means-tested unemployment benefits on our unemployment rate is. Paul Krugman calls out Casey Mulligan for “saying that unemployment is high not because employers have become less willing to hire, but because workers have become less willing to work.”

Let’s go to Casey Mulligan. Here is a quote from him: “employees face financial incentives that encourage them not to work…. [T]he decreased employment is explained more by reductions in the supply of labor (the willingness of people to work) and less by the demand for labor (the number of workers that employers need to hire).” Is that a weird thing to think nowadays? Well, he said that in December 2008 (!), before Obama’s stimulus plan and back when the unemployment rate was 7% (remember those days?). Unemployment rising during a housing crash and financial collapse is the result of government meddling in labor markets. We’ll have to agree-to-disagree there. But I want to go on to some other points.

Two more quotes. Free Exchange rightfully points out, in an excellent entry:

Unemployment benefits clearly do provide an incentive to stay out of work longer. Holding other things constant, we would expect an increase in the generosity of unemployment benefits to lead to more joblessness…

In the absence of unemployment benefits, workers facing job loss would have been forced to liquidate assets to pay for basic necessities (adding to downward pressure on the value of assets of all sorts and leading to an increase in personal and financial institution defaults) and reduce spending sharply, magnifying the initial demand shock.

In addition to a significant increase in human suffering, this would have led to a much steeper and more rapid rise in the unemployment rate…

This is just daft. Yes, without unemployment insurance the newly jobless would have quickly gone back to work—selling possessions for a pittance, working off the books at sub-minimum wage rates, scraping by on charity (nasty incentive effects there, too), begging, stealing, and scavenging—and the country would have been far worse off. For millions of Americans, there was simply no real work to be had at positive wage rates during the worst months of the downturn. Forcing those labourers to get by with no assistance would have been economically catastrophic, and cruel.

This seems entirely correct to me. Will Ambrosini takes issue:

Strange for a magazine with such a name that they don’t know about Alfred Marshall and his marginalist revolution. See, when someone uses marginal analysis to show, unequivocally, that increases (*ahem* marginal increases *ahem*) in unemployment insurance benefits depresses employment, its not ok call them names for not doing inframarginal analysis…

The first $1838 of UI (and food stamps and TANF) keeps families from starving and gives them shelter for a month or so while the bread winners look for new jobs and it prevents them from having to sell off their assets, which, as The Economist mentions, would exasperate the demand shock. Every dollar above that encourages them to search longer and thus increases unemployment….

Free Exchange does bring up this marginal analysis and depressed employment at the beginning, and argues that it is too small to risk a fire sale of household assets. Will says that it must increase at the margin, and that is that.

Fair enough. My questions: how much does the increase in unemployment benefits increase unemployment in this economy? A lot? Is it responsible for half the increase in unemployment? My guess is that it increases it in the same way me buying 1 stock increases the stock price – a negligible and indistinguishable from zero amount.

Why do I believe this? As far as I understand the models, it’s conditional on a “value function”, the chance that you’ll receive a good job offer. You go look for a job, see if you get an offer, compare it to your unemployment benefits, and make a choice. Now what do we know about how looking for a job has changed in the past year? From the big picture:


So when you go and look for a job, in the same way you pick a marble out of a jar, the chances that you’ll find one in any period has fallen off a cliff. Cut in half? a third? It’s a terrible market for job seekers, regardless of whether or not get you a little extra spending cash in a government check. The fact that it is so much harder to find a job makes me think any marginal effect from a little bit more of an unemployment check is negligible and indistinguishable from zero.

I’m willing to be proven wrong, and love back of the envelope estimates. The U3 unemployment rate has gone from 5.6% to 9.5% over the past year, an increase of 70%. How much of that is the result of means testing? .1%? .3%?

The issue that people have with this debate, and you saw it when the panelists at The Week blinkered at Malkin bringing it up, is the presumption that it is a major effect. You get the impression that some people think, with all the issues on the table, that this is one of the major drivers of unemployment – which strikes me as, to use Free Exchange’s term, daft.

Here’s Mulligan’s current view of the unemployed: “Sensible people will recognize that public policies have dramatically reduced the costs to them of searching further for the job they’d like, or making this the year they coach junior’s baseball team, or do some work on their house, or refrain from “coming out of retirement,” or take a trip.” It’s a big country, with all kinds of interesting characters in it, and I have no doubt somewhere someone unemployed thinks right now is the best time to kick back and coach little league on the Government’s dole instead of taking a job offer. But is this a constituency that is anything other than negligible and indistinguishable from zero?

Since the effect may be small, Free Exchange’s point is even more important – we have to worry about fire sales of assets, aggregate demand and widespread misery, and if extending unemployment benefits has a negligible effect it must be true that unemployment is going to be very bad. I want to point out three more things:

1) I believe Will knows his Raj Chetty, so the idea of higher unemployment benefits in periods where work is the most difficult to find is not just about moral hazard of people on the dole but also about people being able to overcome imperfect markets, liquidity and credit constraints. If you aren’t familiar with Raj Chetty on unemployment insurance, I highly recommend you read this slate piece on his research.

2) Means testing mortgage modification, another thing that has caused the unemployment rate to move to 7% and beyond in Mulligan’s world, is less about redistributive justice and more about solving a massive Principal-Agent problems the quants have known about for years but have been unable to hurdle.

3) Higher unemployment spending is a feature, not a bug, of the recovery. Chief Moody’s Economist, and former McCain economic advisor, Mark Zandi concluded that extending unemployment benefits had one of the best bang-for-the-buck ratios for stimulus, second only to food stamps. Consumer savings rate has skyrocketed past 5%, and that is good for them but bad for the economy’s aggregate demand. Tax cuts would automatically be saved, unemployment benefits spent. Why isn’t this a fantastic deal?

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10 Responses to Unemployment Insurance and Unemployment

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  2. In a year when the economy crashed and our financial system – the bastion of American capitalism – was the recipient of one of the largest federal welfare programs ever implemented in our history, it is the height of absurdity to point to unemployment benefits as the reason for the high unemployment.

    Where are the jobs?

    Last Christmas, it was harder to get a temp job at Best Buy than it was to get into Harvard.


    Just one year ago, the unemployment rate was 5.7 percent. Today, it’s pushing 10 percent. The idea that it’s because the American worker is a lazy bum who just wants the government bennies instead of a job is a huge reason why the conservative movement is experiencing a failure of ideas these days.

    What I wish? Those conservative thinkers would use their brains to devise innovative, interesting and well-paid jobs for the unemployed, instead of disparaging the people who’ve been dumped from productive employment this year.

    Show us the money, conservative thought leaders – and by that, we don’t mean bonuses for bankers. We mean jobs with living wages that rise instead of stagnate over time. Not the Wal-Mart job with a salary that is competitive only with unemployment benefits.

  3. lark says:

    Yes it is important to point out the flaws in reasoning.

    But that is not enough to discredit these foolish views, for it is not only good reasoning that is at stake.

    More importantly, the welfare of the American people is what is at stake. The right wing & the libertarians have consistently shown that we could die in large numbers and they wouldn’t care. They ‘care’ about low taxes, that’s it. Make that case to the American people and their base will shrink even further.

  4. Will says:

    Thanks for the link Mike. Yes, I think when we take into account trade-offs between efficiency and equity, the efficiency loss of extending benefits may be outweighed by the gains in equity or fairness (e.g. your list at the bottom of the post). The extent of the efficiency cost is an empirical question, but I,m not sure how to measure benefits of gains in fairness.

    But the question at hand is efficiency: do UI extensions extend unemployment spells and thus drive up unemployment rates? Yes they do.

    Chetty’s stuff shows that liquidity constrained unemployed workers are more likely to find crappy replacement jobs (thus reducing efficiency… resources aren’t optimally allocated). The problem is the liquidity constraint. There are policies that don’t distort the labor decision but deal with the credit constraint… food stamps, TANF, etc.

    (Nitpick: Chetty’s analysis of optimal UI treats the liquidity constraint as structural. Clearly, though, policy can change this constraint. Optimal policy in general is to reduce the constraint.)

  5. To Will – the idea that letting people tap into unemployment longer (or that unemployment gives them more than the starvation wages you mention) “encourages them to search longer and thus increases unemployment” is a bit of a stretch.

    We’re seeing the highest unemployment that we’ve seen in a quarter of a century. This is an extraordinary time and the unemployed are not just the “welfare queens” so loathed by Reagan back in the 1980s once again mooching off the system.

    Where are the jobs, Will? What employment should these people be accepting – out of that big bag of nothing that’s available right now?

    Unemployment is pushing 10 percent. It is 11+ percent in my hometown of Chicago. Nearly 400,000 people lost their jobs in July alone.

    People continue to search for jobs not because they’re loving the life on unemployment but because there are no jobs out there. We saw with the housing market that economists can work magic with math models that enable them to believe just about anything. But numbers aside, UI is extended because unemployment is a very serious problem in our economy – not the cause of it.

  6. Taunter says:

    Terrific article, Mike.

    I might add that even if it were true that the non-subsistence level of unemployment insurance depressed the appetite to work, isn’t it providing an insurance function for the EMPLOYED?

    By creating a social safety net that (allegedly) encourages the unemployed to coach Little League for a year, unemployment insurance mitigates some of the downward pressure on wages (and consequent deflation) that would occur in its absence. To take Anne’s example, do employed Best Buy workers really want armies of desperate people outside the doors Dust Bowl-style grabbing the manager and saying “look, I’ll work for half minimum wage, I walked here, I need to get some food”?

    Of all the things my tax dollars can go towards, I would be thrilled to discover that a significant expenditure was training people on unemployment to be productive when growth comes back and cushioning their transition.

    As it happens, I suspect that for most unemployed people, unemployment benefits are low, unsatisfying, and to be gotten rid of as soon as possible.

  7. “Unemployment benefits clearly do provide an incentive to stay out of work longer.”

    Every day, we face incentives and disincentives. Not only that, there might well be political and social costs to not providing decent UI. In essence, citizens might decide that the system isn’t for them. Programs like UI have a history. The program was meant to solve a problem. Since I’m for a Guaranteed Income, it’s not my preferred solution, but I understand how and why we have the current system. We have a terrible fear in this country of a few people sitting on their ass at govt expense. I don’t care about that at all. I do care about a capitalist system that can sustain itself and have a small govt. Like Milton Friedman, I consider the current system inefficient and less than fair. As well, I think that a Guaranteed Income would be the best Automatic Stabilizer. In any case, pointing out one incentive doesn’t do a lot of good. There are plenty of incentives to take the first job that you can get, especially if it has health insurance and you don’t now, for instance. It’s fair to point out that UI or a GI can cause a few people to move with less energy towards a job, but not to overlook Political Economy, which means trying to take a wider view of how human beings act in the real world.

  8. Crayfish says:

    If you want to deal with the demand shock problem, why give money only to the unemployed (above some subsistence level, we do not want to be mean) ? There may be far more effective ways.

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  10. james peterson says:

    i am 63 years old and have been out of work for over 1year in a state where unemployment is at 15+ %. i have e-mailed, faxed, and in person trying to get any type of work. there seems to be no work for the older worker at this time. unemployment has allowed me to stay in my home, but for how long, i do not know. i hate being on unemployment insurance and would rather be working.

    James PETERSON

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