Monday, November 17, 2014CLEVELAND -- The conventional wisdom, buttressed by economic studies, holds that unemployment insurance deters those laid off from trying to find other work.
Moreover, it’s believed that extending such benefits – to as long as 99 weeks – not only sustains the rate of unemployment, keeping it higher longer, but puts upward pressure on wages while creating fewer jobs.
“A recent study has found that the extensions served to increase unemployment significantly by putting upward pressure on wages, leading to less job creation by firms,” write Pedro S. Amaral and Jessica Ice in the Nov. 14 issue of Economic Commentary published by the Federal Reserve Bank of Cleveland. Amaral is a senior research economist at the Cleveland Fed, Ice a research analyst.
But it’s not that simple, Amaral and Ice found in their analyses of studies that tried, in the wake of the Great Recession, to assess the impact of extended unemployment benefits. (The recession lasted 18 months, from December 2007 until June 2009.)
In response to the high rates of unemployment – reaching 10% nationally in October 2009 -- some states hit the hardest extended the maximum period to receive benefits to 99 weeks. A 26-week limit was the norm before the Great Recession although some states allowed longer, up to 39 weeks in periods of high unemployment.
These extensions “have been criticized for incentivizing workers to stay unemployed and keeping the unemployment rate higher than it would have been otherwise,” Amaral and Ice write.
“As the generosity of benefits increases, unemployment becomes relatively more attractive [and] puts pressure on wages to increase,” Marcus Hagedorn, Fatih Karahan, Iourii Manovskii and Kurt Mitman wrote in their 2013 study, reviewed by Amaral and Ice.
The Hagedorn study differed from others, Amaral and Ice explain, because “it takes into account the impact of extensions on the demand for labor as well as the supply of labor. As a result, firms post fewer vacancies, fewer jobs are created, and unemployment goes up, everything else being the same.”
The Cleveland Fed economists disagree.
“We argue that such a finding is not robust when considering either a longer or more adequate sample,” they write. “We find that this labor demand channel can account for roughly only one-fourth of the increase in the unemployment rate.”
The economics of unemployment benefits, regardless of how long they’re paid, means those laid off have money to spend on the basics -- food, clothing and shelter – but less than if they were receiving a paycheck. They are unlikely to save. Any savings they’ve put away are likely to supplement their unemployment benefits as they wait to be recalled or seek other employment.
The economic argument against unemployment insurance, especially extended benefits, “is that better benefits increase the option value of being unemployed, putting upward pressure on wages and downward pressure on firm profits. As a response, firms will create fewer jobs, resulting in increased unemployment,” Amaral and Ice note. “By making leisure less costly relative to consumption, more generous benefits reduce the incentive to search for a job (what economists call moral hazard).”
This sounds simple enough, the Cleveland Fed researchers allow, but it “extremely hard to assess empirically,” that is, “one would need to compare the U.S. economy to an economy exactly like the U.S. except for the benefits extension.”
The Hagedorn study analyzed data from the first quarter of 2005 until the first quarter of 2012 in Ashtabula County, Ohio, and nearby Erie County, Pa. The four economists (and later Amaral and Ice) looked at counties that bordered each other in adjoining states as well but focused on Ashtabula and Erie counties. They looked at such counties because of their similarities and how long their states would pay unemployment insurance.
In Ashtabula and Erie counties, Amaral and Ice went from 2003 until the end of 2013. “While there were not as many changes in benefits between 2003 and 2005,” Amaral and Ice write, the variations they found were “largely attributable to outside factors, allowing greater precision in estimating their effects on the unemployment rate.”
They conclude: “Our analysis indicates that the impact of extending the duration of [unemployment] benefits during the last recession was positive, but modest compared to other estimates [offered by other economists]. Had the duration of the benefits not been extended, the unemployment rate would have increased roughly one percentage point less from June 2008 to its peak in October 2009, everything else being the same. While this effect is important, it can account only for a fraction of the increase in the unemployment rate.”
SOURCE: Nov. 14 issue of Economic Commentary published by the Federal Reserve Bank of Cleveland.
Published by The Business Journal, Youngstown, Ohio.
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