The effect of unemployment insurance on unemployment

By Felix Salmon
December 9, 2010

Last week, when I wrote my post on how to boost employment, the list started off unambiguously:

The first—and this can’t be stressed enough—is simply extending the federal unemployment extensions. As Menzie Chinn notes, the CEA has scored this, and the numbers are enormous: already, the program has increased the level of employment by 793,000 jobs. If the extensions are kept dead, there will be 593,000 fewer jobs in a year’s time than there would be if they were resuscitated, including more than 46,000 jobs in Florida and more than 26,000 jobs in Michigan.

This is not intuitive, especially to economist types who think that incentives matter and that at the margin, paying people to remain unemployed is not going to increase their chances of getting a job. But the fact is that those unemployment benefits are spent, and the extra economic activity naturally creates employment.

There is of course some effect by which paying people to stay unemployed will increase their chances of doing so. Rob Valletta and Katherine Kuang, of the San Francisco Fed, did the math back in April, concluding that the effect is “relatively modest”:

The question arises whether this extended availability of UI benefits has contributed to a lengthening of unemployment spells because jobless workers are staying in the labor force longer in order to continue collecting benefits. Such a dynamic could raise the unemployment rate. However, analysis of data on unemployed individuals decomposed by their reason for unemployment, which affects their eligibility for UI, suggests that extended UI benefits have had a relatively modest effect. We calculate that, in the absence of extended benefits, the unemployment rate would have been about 0.4 percentage point lower at the end of 2009, or about 9.6% rather than 10.0%.

Peter Coy has taken a detailed look at the interplay between the two effects:

Do the extra checks make unemployment higher than it would otherwise be by paying people to sit at home? Or do the checks sustain growth by supporting the spending power of households with out-of-work breadwinners?

In truth, unemployment benefit extensions do both—they raise the jobless rate a bit, and they make the economy grow faster. What’s clear is that extending jobless benefits makes more sense when the unemployment rate is exceptionally high, as it is now, at 9.8 percent in November… Because aid to the jobless is almost immediately spent (as opposed to tax refunds for the wealthy), it is the most effective means of stimulating demand.

Coy’s “bottom line” is clear: “Although the Obama-GOP tax deal extends unemployment benefits, it probably will not dissuade many jobless from seeking work.”

This all adds up to something reasonably clear. Unemployment insurance isn’t only just from a fairness perspective, it’s also extremely effective as stimulus. Any effect whereby it encourages people to stay unemployed is, in comparison, modest.

Which is why it’s very odd to find Kelly Evans, in the WSJ, writing the exact opposite.

More jobless benefits, more unemployment.

A likely rise in the U.S. jobless rate is the unfortunate reality of the government’s move to fund extended unemployment benefits for another 13 months.

The effect probably won’t be huge, but it will be significant. And it may well hamper any recovery in investor and business confidence.

Evans isn’t very good at math*:

Individuals not actively searching for work or willing to take available jobs may claim they are unemployed in order to receive benefits. That could artificially boost the size of the labor force, which is used to determine the unemployment rate.

Well yes, the labor force is indeed used to determine the unemployment rate, but it’s the denominator in that calculation. If the denominator goes up, the rate goes down. The problem is rather that in any ratio less than 100%, if you increase the numerator and the denominator by the same amount, then the ratio goes up.

Evans concludes:

Policy makers are hoping that extending benefits—along with other tax breaks—will generate enough short-term strength in spending and growth to overshadow any rise in the unemployment rate.

That may prove wishful thinking. The late rapper Notorious B.I.G. probably put it best: “mo’ money, mo’ problems.”

Evans’s piece elicited a smart smackdown from Zack Roth, who actually went to the trouble of phoning up the SF Fed’s Rob Valletta:

“These separate effects act in opposition to one another,” said Valletta. So the question becomes: Which effect is greater, in our current situation?

On this, Valletta was clear. In the current weak labor market, he said, the micro effect is relatively small. “I think the macro economic effects, in terms of reducing the unemployment rate, outweigh the micro effects that increase the unemployment rate,” he said.

This makes perfect intuitive sense, since the macro effects right now are huge, on the order of $60 billion being spent, and 600,000 extra jobs created. It really doesn’t seem plausible, in this economy, that more than 600,000 people will stay out of work and live on their unemployment checks rather than accept a job they would have taken in the absence of those checks; neither does it seem plausible that injecting $60 billion into the economy would send the unemployment rate up.

After Roth’s piece appeared, Evans responded, saying that “we’re all making the same point re: jobless benefits.” (It’s fantastic, by the way, that she’s happy and willing to join the public debate over her stories.) Roth was not convinced, replying that “your point was jobless benefits boost unemployment. everyone else’s is that they cut unemployment. seem like different points.” And so Evans clarified, here and here:

The disagreement is over net effect; will extending UI do enough for growth to overcome the rise in unemployment?

I’m not that optimistic about growth. Extending UI helps growth; but enough to overcome upward pressure on UR?

This misses the point: extending UI would be a good idea even — especially — if growth were sluggish. It’s when the economy isn’t growing that you need to apply stimulus, if only to prevent it backsliding into a double-dip recession. Growth doesn’t need to be high in order for UI to create employment; it just needs to be higher than it would have been absent the extra benefits. If you’re “not that optimistic about growth”, that’s all the more reason to want the fiscal stimulus of extending UI.

Evans might be right that the US unemployment rate is going to rise rather than fall. But if the unemployment rate does rise, the reasons for that rise will be found in the macroeconomy as a whole. Blaming any such rise on the extension of unemployment insurance will be silly.

*Update: This passage was ill-written, or ill-advised, or both. When I reposted this at CJR, I changed it to say that “Evans isn’t very good at explaining the math of why more unemployed people add to the unemployment rate”. I probably shouldn’t have included it at all, though, it’s not central to my point.

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