Reducing the cost of unemployment: The importance of overall impact when designing effective policy

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Research shows that policies designed to encourage people into work have an impact beyond the individual, at a market level. These market effects may produce unanticipated, unintended and even undesired consequences.

 5 min read

Policymakers would do well to consider the cumulative impact, at both an individual and market level, to ensure they are designing effective policies.

LaliveRafael Lalive is a professor of Applied Economics and Econometrics. His research interests include social economics, labor economics, public economics, microeconometrics.

A productive workforce is a valuable commodity for any regional or national economy. Consequently, finding the best ways to help the unemployed into work has always been an important – and costly -challenge for policymakers. Take unemployment insurance (UI), for example. This common method of supporting the unemployed makes up a significant proportion of government spending in many nations. In 2015, total unemployed insurance benefits in the US cost some $30bn.

How much should be paid and for how long?

Yet, despite the vast sums involved, the most effective way to implement unemployment insurance remains unclear. How much should be paid and for how long? Under constant pressure to cut budgets and use public funds wisely, it is essential for policymakers to understand the relationship between the financial support offered and job seeking outcomes.

The unemployment challenge

Unemployment insurance (UI) is both a contentious and complex issue. In the US, for example, where provision is a mixture of State and Federal funding, there is fierce debate about the best way to support people into work. Provisions were made to extend UI duration beyond a standard 26 weeks, partly dependent on the percentage of claimants and regional unemployment rates. However, there was subsequent disagreement over the efficacy of the provisions and whether they should continue. Some pointed out, for example, that unemployment rates appeared to track the length of time the benefits were available for. Did extending UI cause or perpetuate unemployment?

Understand the complicated relationship between financial support, job search behavior and employment outcomes

These issues are not only contested in the US. Around the world policymakers attempt to extract maximum value from spending directed at alleviating unemployment. But to do this, they need to understand the complicated relationship between financial support, job search behavior and employment outcomes. This is where research by Rafael Lalive, Professor of economics at HEC Lausanne and co-authors, Camille Landais and Josef Zweimuller, provides new and important insights.

To gauge the true effect of UI policies it is necessary to consider their overall impact. The most obvious effects are apparent at an individual level – take two people receiving UI for different periods of time and observe any differences in job search outcomes. Evidence indicates, for example, that the longer an individual receives unemployed benefits for, the longer they take to find a job.

If some individuals are granted an extended period of unemployed benefits this may increase the overall return for job searching efforts in that labor market

Having established micro level effects it is tempting to extrapolate them to a regional or national level and devise or adjust policy accordingly. However, the research by Lalive et al. suggests other factors must be taken into account. Unemployment insurance availability has a broader impact at a market level which modifies effects at the individual level. For example, given a finite number of vacancies, the job market can easily become congested, reducing the probability of obtaining work. However, if some individuals are granted an extended period of unemployed benefits and are less active at job searching as a result, this may increase the overall return for job searching efforts in that labor market.

Individuals under less pressure to find work quickly, may engage in wage negotiation

Another possible market effect concerns wage negotiation. Individuals with extended UI, under less pressure to find work quickly, may engage in wage negotiation. If job searchers negotiate wages up firms may reduce vacancies. A reduction in vacancies will have a negative impact on job searching efforts.

Lalive and his co-authors tested the consequences of extended durations of unemployment insurance at the market level. To do this they used Austrian employment data from the 1990s that encompassed a period during which UI was extended to four years for certain categories of individuals, but only in particular regions of Austria – the Regional Extension Benefit Program (REBP). Eligible individuals had to be aged 50 or over and in continuous employment for at least 15 of the previous 25 years. The extension was a policy response to problems in the steel industry. Because the extended duration was only available in some parts of the country and not others, but to all workers who met the criteria, it afforded the perfect opportunity to study the effects of that social policy on the job search market.

Imagine REBP region A extends the duration of unemployment insurance to four years for a group of workers. Region B, however, does not implement the policy. How do non-eligible workers in region A fare in their job search, compared to similar workers in region B?

The data reveals strong evidence for a “congestion” effect at a market level. Non-eligible male workers aged between 46 and 55  in REBP regions were unemployed for significantly less time than their non-eligible counterparts in regions where extended benefits were unavailable.

Furthermore, Lalive et al. directly compared the non-eligible over 50s, but with less than 15 years continuous work history, segment in both the REBP and non-REBP regions. The effect was even more pronounced. Prior to the REBP program the length of unemployment spells was similar for both. During the REBP period, non-eligible over 50s in the REBP region experience much shorter periods of unemployment compared to their non-REBP counterparts. Even though they are competing in the job market against over 50s with a better employment track record.

The authors also looked at industries that were tightly integrated across REBP and non-REBP regions and discovered a spillover effect. Non-eligible job searchers in regions adjacent to the REBP regions also obtained work more quickly.

Considering market effects

The message for policymakers is not to assume that the impacts of welfare policies can be determined just from the evidence at an individual micro level. Social welfare policies, such as those designed to encourage the unemployed into work, also have an impact at the market level. This may amplify the effect observed at the individual level, reduce it, or make little difference. But these market effects, often unanticipated and unintended, must be considered.

A temporary period of UI extension may be very effective

For example, if an industry in a particular region is struggling it might seem sensible to assist workers by extending unemployment benefit duration in that region. The challenge is deciding how long any UI extension should last. The research shows that, in addition to any micro effect, such a policy will have market consequences for job seekers. Those market effects suggest that a temporary period of UI extension may be very effective. Longer term solutions might be more costly since they would eventually depress the job market.

The paper by Lalive et al. explains how policymakers can assess the relationship between the micro and market effects, and the impact at a macro level. In doing so, it enables them to use public funds in a more cost-effective way, and implement policies that benefit society and the global economy more widely.

Read the original research paper: Market Externalities from Large Unemployment Insurance Benefit Extension Programs, revised 2015, Working Paper (CESifo, CEPR, and IZA), with Camille Landais and Josef Zweimüller.

Featured image by shironosov / istockphoto