Is Extending Unemployment Insurance Good for the Economy?

by: Rortybomb

Allright, this goes out to the financial engineers in the audience. How many of you caused a ton of damage in the financial economy because you never really got a solid handle on modeling liquidity in your theories and work? Raise your hands. It’s ok, this is a safe space. (Slight hand raise here.)

Don’t feel too bad, because certain academics, economists and government ideologues are going to cause a ton of damages in the real economy by arguing against unemployment insurance without also having a decent theory of liquidity. People are worried about the bad incentives of unemployment insurance in the abstract, but they are confusing bad work incentives with the effects of “cash-on-hand” (liquidity). So let’s look at some evidence.

Here’s two presentations from Raj Chetty at a recent Economic Policy Institute event on the long-term unemployed. He presented his research about where unemployment insurance stands not in a liquidity trap, not in a major recession, not when there are 5+ job seekers per job opening, but in normal times and through the efficiency lens of an economist:

Here’s his presentation as a pdf. If you are a liberal who wants to defend the social safety net, you should learn how to wield this argument like a katana blade. There’s three reasons why unemployment insurance is valuable: it’s valuable to people as when they are unemployed is when the marginal value of a dollar is very high. Many people have trouble borrowing when they are unemployed, and evidence (we will discuss tomorrow) shows that the people have to make very painful consumption cuts. As Raj notes: “Consumption-smoothing benefit of providing UI large because unemployed families are cash-constrained, median unemployed person has less than $250 in net savings prior to job loss and cannot borrow, and moreover, most families have many commitments that they cannot adjust.” People are liquidity constrained.

Now when you have higher unemployment benefits, you’ll see that people take longer to find a job. Conservatives point to this as a “work disincentive effect” – you are paying people to not work, and sure enough they aren’t working. Since they could be doing productive work but they are choosing not to, this hurts the larger economy.

However this effect seems to be concentrated among people with very low liquid wealth. See how people in states with high unemployment benefits take a longer time to find a job:

But if you look at the top of that graph, you’ll see that it’s for people with negative liquidity (the household holds short term debt that needs to be paid). What if we look at people with a fair amount of cash on hand:

If you check out the presentation there’s even less difference with people with more savings than that. From an economic viewpoint what we are concerned about is a work disincentive effect, that the insurance creates a moral hazard where people would not take a job that they otherwise would to get the insurance. But we don’t see this: there’s no reason that people with more savings should feel a work disincentive effect less than those with poor savings.

In fact, one of my favorite instrument experiments does just this. From Cash-on-Hand and Competing Models of Intertemporal Behavior: New Evidence from the Labor Market, in Austria you get a lump sum of cash if you worked more than 36 month at your previous job. There should be no work disincentive effect from this; the cash doesn’t go away whether or not you get another job, as it does with unemployment insurance. And sure enough, we see the same issue:

On the left, there is no lump sum unemployment payment. Just giving people a bag of cash makes them take an efficiently longer amount of time to find a job, even though there isn’t a work-disincentive tying the payment to being unemployed. From the presentation of this paper: “Conclusion: 2/3 of the effects of UI effects on increased durations is a beneficial “liquidity” effect rather than a harmful work disincentive effect.” This is people searching for a job they fit into better, this is people making their basic payments and obligations, hedging against future risks and future financial ruin, this is people being able to efficiently make the choices for how to fix back into the economy.

So when we look at this, even in normal times, the benefits outweigh the work disincentive costs. Now the long-term unemployed, who have depleted their savings, who have a hard time finding a job period in the current economy, would gain the most from unemployment insurance. And that’s even before the macroeconomic effects. And it’s even before the interesting problem of subsidizing people to look for a job (which unemployment insurance requires) rather than join the long-term unemployed, where some current research shows that human capital depreciates at an alarming rate, which we will talk about shortly.

So really, every slice you look at it, extending unemployment insurance is a smart move. Good on policy, good for the macroeconomy, and good for people. It’s a shame Congress doesn’t see it this way.

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