sou · GZB32 · 2011-01-18 00:00:00 — Empirical problems are mainly due to the complica- tions in evaluating policy interventions, which are often the result of non-random assignment to particular interventions. If individu- als exposed to an intervention are not similar to those not exposed to the intervention, a simple comparison of the outcomes of parti- cipants and nonparticipants gives a biased and inconsistent estimate of the effectiveness of the policy intervention. In this paper, we mainly consider research which convincingly deal with selective participation. Theoretical complications are mainly due to technical difficulties in specifying and solving complicated dynamic models with moral hazard. We focus on policy interventions which aim at reducing moral hazard in the labor market which go beyond reducing benefits. Examples of such policies are screening benefit applications, job search monitoring, sanctions and reemployment bonuses. This paper should thus complement earlier surveys.1 We also consider sickness and disability programs. Although not exclusively, we often rely on empirical evidence from the . This is not only because of our familiarity with the Dutch situation, but also because of similarities between and the . Both countries have relatively large expenditures on labor market programs, and have as a main problem a relatively large degree of long-term sickness absenteeism and dependency on DI. The experienced some institutional reforms in the past decade, which provide value insight for other countries such as . Furthermore, we provide a strong link between the theo- retical literature and empirical studies. This allows us to check both the validity of the theoretical predictions and report the effects of the policies in question. Finally, we try to obtain insight in how different programs inte- ract and briefly consider the large scale use of policy interventions. There is some evidence that changing entitlement rules of, for example, DI affect the size of the UI and other welfare programs. In order to get an idea of the welfare effects of policy interven- tions, it is important to acknowledge that besides the positive effects of making it easier for firms to fill their vacancies if indivi- duals search more intensively, there might also be negative spillover 1 E.g. and (2006) and Kluve et al. (2007). Bilaga 8 till LU2011 These are due to unemployed workers competing for the same job. We discuss some recent models that take those effects in consideration. The remainder of this paper is organized as follows. In Section 2 we provide a discussion of moral hazard in benefit schemes and mention some general policies to reduce moral hazard problems. We focus on unemployment benefit schemes and policies targeted at unemployed workers in Section 3. In Section 4 we consider sick- ness and disability benefits schemes. Next, in Section 5 we consider general equilibrium issues, which have not been discussed in the previous sections. Finally, Section 6 concludes and gives some policy advice for . 2Moral hazard in benefits schemes: models and policy Most countries provide unemployment insurance (UI) because workers have a to insure themselves against income risk. This insurance is typically not provided by market parties because of systematic risks (after a sufficiently bad macro shock many workers lose their jobs and the insurance companies would run the risk of going bankrupt). A second reason why the market does not provide this insurance is that workers often have more information about their unemployment risk than firms, and therefore high risk workers are more likely to buy insurance (this is called adverse selection). Another general problem of insuring workers against income risks (whether it is by the state or by the market) is that this induces behavioral responses (moral hazard). Those responses can be desirable, i.e. if workers are strongly risk averse UI benefits may stimulate workers to accept jobs in risky sectors, but they can also be undesirable if unemployed workers do not provide enough effort to find new jobs. The market response to this is to not offer full insurance. In this section, we argue that monitoring unem- ployed workers can make all workers better off because it allows for more insurance and at the same time stimulates workers to pro- vide more effort. There exists evidence that countries with generous benefits often have lower reemployment rates. For example, European labor markets, which have high benefits and long entitlement periods, are characterized by long average durations of unemployment.2 This is not just an association, but there is a convincing empirical litera- ture, which shows the causal effect of the generosity of a benefits program on the duration individuals remain dependent on bene- 2 This is extensively discussed in and Sargent (1998) and Bean (1994). Moral hazard in benefits schemes: models and policy Bilaga 8 till LU2011 fits.3 There exists strong evidence that moral hazard problems are more pronounced in more generous benefits schemes. This finding is not specific to UI, and in Section 4.1 we provide empirical evi- dence of moral hazard in SI/DI benefit programs. Moral hazard problems have been acknowledged by policymakers in the past two decades, and therefore they have become interested in instruments to stimulate reemployment. In most Northern European countries (e.g. , , the ), expenditures on labor market programs are high. Before focusing on policies that aim at reducing moral hazard, a first necessary step is to discuss some considerations about setting up a benefits program. Policy makers must typically decide about the initial level of benefits, the entitlement period and the slope at which benefits reduce over time. In order to determine the optimal level of benefits, they must trade off moral hazard incentive effects (i.e. lower search effort, more choosy workers) with the to support unemployed and disabled workers. Of course, moral haz- ard differs between benefit and insurance types. For example, if the degree of disablement is perfectly observable, it is clear that moral hazard is less of an issue than if the insurance administration only has an imperfect measure of the seriousness of the impairments. Another important factor for the trade-off between incentive effects and benefits support is the extent to which workers can save and borrow against future income. If workers have easy access to liquidity either from savings or from loans, optimal benefit levels can be low (particularly for UI). Recent work emphasizes the importance of separating available liquidity from the insurance aspect. Liquidity is important for con- sumption smoothing while UI benefits insure workers against long spells of unemployment and clearly those are different issues. Therefore, if workers are identical, risk averse and the environment is stable over time, benefit levels should not be reduced over time (as is the conventional wisdom) because those with the longest unemployment spells are the ones who lose most income. An intuition for this result is that when the trade-off between moral hazard and insurance does not change over time, the associated benefit level should neither change. Of course, if human capital 3 Lalive (2008) shows that if the entitlement period for UI benefits is extended, then the exit rate to work gets lower. (2001) find for that a higher level of benefits also reduces the exit rate to work. See also the references mentioned in these papers for further empirical evidence. Bilaga 8 till LU2011 Moral hazard in benefits schemes: models and policy depreciates over time or if workers vary in terms of their value of leisure, the insurance-incentive trade-off will change over time for the average worker and it becomes desirable that benefits change as well. An important limitation of the theoretical literature on dynamic moral hazard problems is that it is often partial in nature (only the behavior of unemployed job seekers is considered). Recently some progress has been made with equilibrium models (taking also firm behavior into account) which focus on the trade-off between high taxes, less jobs and full insurance on the one hand, and low taxes, many jobs and incomplete insurance on the other hand. This lit- erature concludes that UI benefits should be equal to the wage at the moment a worker is fired (for consumption smoothing rea- sons) and then fall over time (else the worker will not accept jobs). However, these models ignore savings by workers. It is, therefore, not clear to what extent the negative slope is implied by this restriction or by this equilibrium extension. Another important issue is the financing of the benefits of workers who become unemployment. If this is studied in a static framework, the conclusion is that this should be financed through firing taxes because firms do not internalize society's cost of financing UI benefits. However, in a static model, the job creation problem is absent. In a dynamic model layoff taxes are necessary but firms should also receive job creation subsidies to offset the negative employment effects of those taxes.4 The considerations above have stimulated the discussion about introducing mandatory saving accounts for workers (as is the case in ) to pay part of the UI or DI benefits. If an individual is short of funds, she can borrow from the government. However, such a system might lead to excessive savings. To sum up, if firing a worker implies a negative externality on society and should be taxed, then for the same reasons hiring should be subsidized. If the administrative costs of those taxes and subsidies are high, it is better to skip both. Also, the theoretical literature evaluating policy interventions and benefits jointly is still in a very early stage. Models are in most cases partial, while policy interventions might also have general equilibrium effects. We return to these general equilibrium effects in Section 5. If we define optimal policies as policies that maximize the welfare of an unemployed worker, then it depends on the 4 See for example the matching models in the vein of and Pissarides (1994). Moral hazard in benefits schemes: models and policy Bilaga 8 till LU2011 benefits received and future income discounted by the rate at which a worker enters employment. When using a mixture of poli- cies, it is crucial that they interact well.5 For example, a system of sanctions to reduce moral hazard can make all workers better off if it reduces the unemployment duration, increases UI benefits and/or reduces taxes. Let us consider the following policy instruments: (i) UI bene- fits conditional on job search, (ii) monitoring and job search assistance, (iii) low welfare benefits, and (iv) workfare. The differ- ences between the instruments are the effort levels required from the unemployed worker and the costs for the government. If workers lose human capital while unemployed, optimal policies involve switches. For example, if a country chooses high UI bene- fits, it is optimal to provide monitoring and job search assistance after a few weeks if the worker has not accepted a job yet, and next only provide welfare benefits if the worker still has not found a job. Alternatively, if initial UI benefits are low, it is optimal to offer workfare after a few weeks if the worker has not found a job yet. The conclusion from this discussion is that it is important not only to look at the instruments in isolation but instead take the interac- tion into account. 5 See Pavoni et al. (2009). 3Evidence on policy interventions reducing moral hazard for unemployed workers In this section, we discuss existing policies to reduce moral hazard for unemployed workers. In most European countries, labor market policies have been developed since the early 1990s. Many of the early programs were job search assistance and monitoring pro- grams. During the mid 1990s many countries also started investing in training and schooling programs for unemployed workers and subsidized employment programs were introduced. An extensive literature survey indicate that the institutional environment does not seem to be very important for the effectiveness of policy inter- ventions.6 , we provide more insight in those policies, which aim at reducing moral hazard. Studies indicate that such programs are more effective in increasing the exit rate to work than policies trying to improve human capital.7 We mainly ignore the latter type of policies. 3.1Job search monitoring and sanctions As discussed in Section 2, moral hazard implies that unemployed workers devote less effort to job search in the presence of generous benefits. The most straightforward method to reduce moral hazard is thus to require benefit recipients to devote a substantial amount of effort to job search. To make sure that benefit recipients comply with the job search requirements, the benefit agency should have 6Kluve (2010) surveys about 100 evaluation studies of labor market programs in Europe. 7See also Card et al. (2009). Evidence on policy interventions reducing moral hazard for unemployed workers Bilaga 8 till LU2011 the possibility of punishing benefit recipients for noncompliance. This is usually done with sanctions, which temporarily reduce the benefits level. we consider job search monitoring and sanc- tions. Imposing job search requirements and strict monitoring of the worker's effort usually implies that the worker should increase her level of job search effort. The worker cannot behave as she would have preferred, and she dislikes being on the benefits program more than without the strict monitoring of the job search require- ments. To leave the benefits program, the worker is thus willing to accept also less well suited jobs. So strict monitoring of search requirements make the worker search and accept more jobs, implying that the exit rate to work increases. A worker might suf- fer from having to accept a less suited job.8 This might cause that individuals more often return to unemployment again. However, often on-the-job search is more efficient than job search while being unemployed and it reduces the risk of skill loss. Finding a first less suited job quickly might thus be a stepping-stone towards better suited jobs. The key assumption for a positive effect of job search monitor- ing on reemployment, is that the benefits agency is capable of monitoring relevant job search effort. If the benefit administration can only imperfectly monitor job search effort, this substantially reduces the effectiveness of job search monitoring. Benefit recipi- ents will substitute effort from informal search channels (which cannot be monitored) to formal search channels (which are moni- tored).9 search monitoring is, therefore, ineffective for benefit recipients who would devote much effort to informal search and those are typically unemployed workers with relatively good labor market . The implication is that monitoring might be more effective in stimulating reemployment of more disadvantaged unemployed workers, such as the long-term unemployed and indi- viduals with a relatively large distance to the labor market. It is obvious that job search monitoring is ineffective without the threat of imposing sanctions. Such punitive benefit reductions can have two effects. First, an ex-ante effect implying that if the unemployed worker knows that if she does not comply with the rules of the benefit agency, there is a risk of getting a sanction. 8Arni et al. (2009) discuss this issue. 9Van den and (2006) provide empirical evidence on this substitution effect. Bilaga 8 till LU2011 Evidence on policy interventions reducing moral hazard for unemployed workers Therefore, many unemployed workers will increase their level of job search effort to reduce the risk of getting a sanction. However, there are still unemployed workers who prefer a low job search effort and being at risk of getting a sanction, over a high level of job search effort and a reduced sanction risk. The level of sanctions should increase rapidly when increasing the minimum required job search effort.10 If a sanction is imposed on unemployed workers, they not only temporarily face a reduced benefits level, but often also enter a regime of more intensive monitoring. The ex-post effect of actually imposing a sanction is caused by unemployed workers increasing their job search effort and reducing their reservation wages. The reemployment rate increases, and this effect is perma- nent if the more intensive monitoring is important. To summarize the discussion above, job search monitoring and sanctions increase the level of job search effort. It is often argued that employers will open more vacancies if unemployed workers are searching for work more intensively and are willing to accept more job offers.11 However, it might be that the additionally cre- ated jobs, on average, have a lower quality. One should thus be careful not to increase the job search requirements too much. Thus determining the optimal levels of job search requirements, moni- toring and punishments for noncompliance are empirical questions. 3.1.2Practical implementation of job search monitoring and sanctions The theoretical discussion above considers sanctions given for lack of job search effort. However, in many countries sanctions are also given for other reasons. This can be unnecessary job loss, unwillingness to participate in labor market programs, fraud or not providing information, and not accepting suitable job offers. In the , sanctions are imposed by a separate depart- ment within the UI administration or welfare agency responsible for enforcement. The department starts an investigation and a pos- sible sanction procedure after noncompliance has been reported. Such a report can come from the caseworker of the benefit agency who is responsible for monitoring the behavior of the benefit recipient. However, other organizations can also report noncom- 10See Abbring et al. (2005) for a discussion on the potential effects of sanctions. 11See et al. (2007) for a more extensive discussion. Evidence on policy interventions reducing moral hazard for unemployed workers Bilaga 8 till LU2011 pliance to the rules, for example, the public employment office, agencies providing labor market policies or employers (for example, after refusal of a job offer or unnecessary job loss). In the sanction policy is not much different from the , with the exception that a sanction is preceded by a warning and thus only the second violation of the rules results in a benefit reduction. In the , warnings are only used for minor noncompliance or in case of mitigating circumstances, and are only given once. Furthermore, in the sanctions are imposed at a decentralized level, i.e. local offices have discretionary power. In , it is always the public employment office who reports noncompliance to the UI fund imposing the sanctions. In the , sanctions usually range from a to benefit reduction during between 4 and 16 weeks. According to the guidelines, providing information about, for example, sickness late should be punished with a reduction during 4 weeks and insufficient job search or refusing suitable job offers are punished with a reduction during 16 weeks. However, there is some discretionary power. In case of mitigating circumstances the reduction may be reduced to half the indicated reduction. Fur- thermore, in cases of serious fraud, the benefits may be terminated immediately. It is often argued that sanctions are accompanied with a stricter regime of job search monitoring. In also the possibility to impose short punishments (2–3 days benefit exclu- sion) exists and constitutes the vast majority of all sanctions imposed. In the , sanctions are imposed during about of the (starting) welfare spells, and of the recipients receive warnings. In the UI, the sanction rate is slightly higher; during about of the spells at least one sanction is imposed. It should be stressed that UI benefits spells are, on average, much shorter than welfare benefits spells so the monthly risk of getting a sanc- tion is higher for a UI benefit recipient than for a welfare benefit recipient. The sanction risk in seems to be much lower, although it should be noted that the system has been made stricter in the last decade, which has increased the incidence rate of sanc- tions. The Swedish experience is different. In monitoring mainly focuses on whether benefit recipients refuse suitable job offers. This does not seem to be optimal because it might discour- age unemployed workers from searching . Bilaga 8 till LU2011 Evidence on policy interventions reducing moral hazard for unemployed workers case, a benefit recipient not making any job applications will not get any job offers and can thus not be punished for not accepting job offers. Thus benefit recipients who apply to many jobs, but who receive relatively bad offers, will be punished more severely than those who do not apply at all. Therefore, caseworkers should first make sure that benefit recipients apply for jobs sufficiently, and next enforce that benefit recipients accept suitable job offers. The sanction rate in is much lower than in other European countries, and in contrast to most other countries the sanction rate has not increased in the past decade.12 An important reason for the low sanction rate is that in monitoring are performed by caseworkers rather than by a separate department within the bene- fit agency. Caseworkers might be much more reluctant to impose sanctions, since they also meet regularly with the benefit recipients to assist in job search. 3.1.3Empirical evidence on job search monitoring In many countries, job search monitoring is one of the oldest labor market policies. It involves checking the actual search behavior and it is often provided jointly with advising unemployed workers in their search for work. In various countries there have been randomized experiments to evaluate the effectiveness of such policies.13 Mixed results are found for the effectiveness of job search monitoring. How can we explain this? The effectiveness of job search monitoring depends strongly on the target population. We discuss this in more detail below. search monitoring usually consists of regular meetings between the caseworker of the benefits administration (or public employment office) and the unemployed workers. During these meetings recent job search effort is evaluated (monitoring) and the unemployed workers are advised in their future job search (coun- seling). Obviously, if the caseworker detects a lack of job search effort, the unemployed worker should be punished with a tempo- rary reduction of the UI benefits. In the , there have been two experimental studies of the effectiveness of job search monitoring for UI benefits recipi- 12See and (2009) for a recent discussion on . 13See, for example, Gorter and (1996) and and (2006) for the , Ashenfelter et al. (2005) and and Klepinger (1994) for the US, and Dolton and O'Neill (1996) for the UK. Evidence on policy interventions reducing moral hazard for unemployed workers Bilaga 8 till LU2011 The target population in Gorter and (1996) contains on average more disadvantaged recipients and also macroeconomic conditions were worse in 1989/1990 compared with 1998/1999. Furthermore, they study an increase of the usual level of monitor- ing, while and (2006) study a decrease of the usual level of monitoring. Gorter and (1996) find that the effect of counseling and monitoring on the job find- ing hazard is modest and insignificant for individuals who previ- ously had a permanent contract, and significantly negative for indi- viduals who previously had a temporary contract.