sou · GZB32 · 2011-01-18 00:00:00 — Their findings show that thanks to its economy-wide risk-pooling, unemploy- ment insurance enables a high degree of consumption smoothing for all categories of workers, performs well under idiosyncratic, sectoral, and regional shocks, and acts as an automatic macroeco- nomic stabilizer. But studies also find that unemployment insur- ance creates reemployment disincentives and contributes to higher equilibrium unemployment. However, the magnitude of disincen- tive effects is not a firmly established parameter, and the literature is inconclusive and rather thin on important aspects. To stimulate workers to search for a job several incentive mechanisms are intro- duced. These mechanisms can be grouped under three headings: sequencing of benefits, monitoring and benefit sanctions, and workfare (see also and , 2006a and 2006b). Since there are separate reports on monitoring and benefit sanctions and labor market policies,1 we focus on the incen- tive mechanisms which influence either the outflow from the UI system, such as the level and duration of unemployment benefits, or the inflow into unemployment, such as eligibility criteria. As we mentioned in the introduction, we also discuss in Section 3 the interaction of UI provision with labor market programs and programs of social assistance. In this section, we provide a review of the theoretical literature on the functioning of the UI system. We make a distinction between unemployment inflow and outflow and their effects on equilibrium unemployment. In addition, we discuss how this analysis relates to the optimal design of the UI system. 1 See and van der Klaauw (2010) and and (2010). Bilaga 9 till LU2011 We start with a discussion of how the benefit level and the duration of benefits affect the re-employment probabilities of unemployed workers.2 Unemployed workers can influence the exit rate from unem- ployment to work by choosing how much effort to exert in searching for a job and by choosing the minimum wage that they require for accepting a job offer. With a fixed duration of benefits the main theoretical prediction is an increasing job finding rate over the spell of insured unemployment. This is the result of a drop in the value of unemployment the closer the worker is to benefit exhaustion. As a result of this, closer to benefit expiration job seekers exert more search effort and are more willing to accept lower wage job offers. The change in the behavior of job seekers over the spell of unemployment implies that individuals with different lengths of benefit entitlement behave differently.3 An increase in the potential benefit duration entails only a small immediate disincentive effect, that is, at the beginning of the unemployment spell. The largest effect of an increase in benefit duration is expected for unemploy- ment durations close to the benefit expiration period before the change of the system. This is because search intensity at that time will be significantly lower under the new system with longer bene- fit duration compared to the system without a benefit extension, in which search intensity is at its highest level. An increase in the benefit level will also affect unemployed workers differently depending on their elapsed unemployment duration. Contrary to an extension of the benefit duration, an increase in the replacement rate has its largest effect at the start of the unemployment spell. For a recent unemployed worker, an increase in the benefit level will lower the exit rate from unem- ployment as a result of a higher value of unemployment. The job seeker will reduce the search effort and will demand a higher wage before accepting a job offer. For an unemployed worker close to benefit exhaustion, an increase in the benefit level might lead to an increase in the exit rate. This occurs because the immediate gain from the increase in the benefit level is small, while the value of becoming qualified for 2This analysis is based on the job search model developed by (1977). 3Van den (1990) discusses the sources of non-stationarity in job search. Bilaga 9 till LU2011 benefits in the future increases. This entitlement effect increases the incentive to accept jobs for UI recipients close to benefits exhaus- tion and for those who are not eligible for unemployment benefits. Theoretically, the overall effect of an increase in the generosity of benefits on the duration of unemployment is ambiguous. On the one hand, a higher amount of benefits and a longer benefit dura- tion will lower the exit rate from unemployment. On the other hand, for those close to benefit exhaustion more generous benefits will create an incentive to find a job faster. Given that the entitle- ment effect refers to future benefits its effect is expected to be smaller than the direct effect of more generous benefits. With a small entitlement effect, we expect increases in the benefit level and benefit duration to lead to lower job finding rates and longer unemployment durations. The benefit system may also affect the inflow into unemployment by changing the participation decisions of inactive individuals, the quitting behavior of workers and the firing decisions of firms. These decisions can change either because of an increase in the generosity of the benefit system or because of a change in the eli- gibility criteria for receiving unemployment benefits. Rather than being employed or unemployed, individuals may decide not to participate at all in the labor market. When unem- ployment benefits are paid only to job-seekers, that is, inac- tive people do not receive the benefit, an increase in the generosity of benefits might increase aggregate labor force participation. The intuition is that the entitlement to higher income while seeking jobs induces more people to be engaged in job search. Thus unemployment benefits may actually increase participation. Unemployment benefits may also affect unemployment via a higher inflow from employment. This higher inflow can be either because firms are more willing to fire workers or because workers are more willing to quit their jobs. On the firms side, more gener- ous unemployment benefits exert an upward pressure on wages, which makes newly established jobs become unprofitable more quickly. As a result, a more generous benefit system will lead to an increase in the steady state flow from employment to unemploy- ment (and Pissarides, 1999). On the workers side, more Bilaga 9 till LU2011 generous benefits might induce individuals to quit more easily raising the inflow into unemployment. A mechanism to reduce the incentive for workers to quit their job in the presence of unemployment benefits is the imposition of a tax upon entering unemployment. This tax is typically in the form of a waiting period during which workers do not receive benefits. Additionally, the eligibility criteria for receiving benefits may be used to control the inflow into unemployment. Specifying a minimum employment period to contribute to the unemploy- ment insurance fund is a way to avoid repeated cycles of short employment followed by receipt of unemployment benefits. Unemployment insurance may not only create disincentives in job search but may also affect post-unemployment outcomes. There are different potential mechanisms and relevant outcomes. First, more generous benefits will have a positive effect on the re- employment wages. The intuition is that with higher benefits unemployed workers become more demanding in terms of the wages they are willing to accept. Second, more generous benefits act as a search subsidy (Burdett, 1979) because they provide unem- ployed workers the time to find not just a job but the right job. In a labor market with search frictions, benefits tend to reduce job mismatch since unemployed workers become more selective and accept only highly suitable jobs, which are less likely to dissolve, and increase their productivity (Marimon and Zilibotti, 1999). Finally, more benefits may increase the number of high-quality jobs in the labor market. Moderate encourages unemployed workers to apply for high-wage jobs with high unemployment risk and this may induce firms to create more high-quality jobs (Acemoglu and Shimer, 1999). Unemployment benefits, therefore, might have an effect on job match quality through higher wages and employment stability. We discussed earlier that more generous benefits will increase the inflow into unemployment due to more firing by firms when a productivity shock reduces their profitability. To the extent that UI increases the quality of the matches between workers and firms and thus increases the workers productivity, this might mitigate the effect of UI on the inflow into unemployment. Bilaga 9 till LU2011 Steady state unemployment depends on the inflow and outflow rates. The overall effect of an increase in the generosity of UI on the unemployment rate depends on its relative effect on the two flows. In this part, we discuss how UI might affect the equilibrium unemployment (Lalive et al., 2011). Starting with the outflow rate, the discussion in Section 2.1.1 suggests that increasing the generosity of UI has two opposite effects on the exit rate out of unemployment. First, the value of being unemployed increases so there is a disincentive effect that leads an unemployed worker to search less intensively. Second, the value of being employed increases (because the value of being unemployed in the future has increased) which has a positive effect on the exit rate. For the short-term unemployed the disincentive effect dominates, especially with an increase in the benefit level. For unemployed workers near the point of benefit exhaustion (and beyond), and for those not eligible to benefits, the incentive effect dominates. Therefore, an increase in the level of benefits will have a negative effect on the exit rate out of unemployment for the short- term unemployed but it will have a positive effect on the exit rate for the long-term unemployed and for the non-eligible. Therefore, the effect is a priori ambiguous but is more likely to be negative as the direct effect of an increase in the value of unemployment is lar- ger than the indirect effect of an increase in the value of unem- ployment in the future. An extension of the maximum benefit duration affects the behavior of unemployed workers with the larg- est effect being expected for unemployment durations close to the benefit expiration date. The increase in the value of being unemployed through an increase in the generosity of UI may also induce an increase in the inflow into unemployment. There are various reasons why this could be the case. First, an increase in the value of unemployment might create an incentive for those who are inactive to participate in the labor market. Second, more generous benefits push up wages and increase firms' reservation productivity. This means that firms might be more likely to fire workers as a result of more generous benefits. In the case in which UI leads to higher job match quality with increased productivity this might mitigate the effect of UI on the inflow into unemployment. Third, more generous benefits may Bilaga 9 till LU2011 induce a worker to quit his/her job more easily and finally, may also increase the take-up of unemployment benefits. In conclusion, from a theoretical point of view, it is likely that an increase in the generosity of the UI system (benefit level or duration) will increase the equilibrium unemployment rate because of its overall positive effect on the inflow rate and the overall nega- tive effect on the outflow rate. 2.1.5The optimal design of UI The optimal design of UI needs to consider the trade-off between consumption smoothing through insurance and incentives to search for work. If the search effort of unemployed workers could be observed and verified then there would be no moral hazard problem and the optimal design would entail full insurance with a profile of benefits over the unemployment spell. In the presence of moral hazard the design of the UI system should pro- vide unemployed workers with incentives to exert search effort. A UI system with a declining sequence of benefits has been considered optimal in the presence of moral hazard because it pro- vides stronger incentives to search (Shavell and , 1979; Hopenhayn and Nicolini, 1997; Pavoni and , 2007). Most countries have a system with a declining sequence of bene- fits through a two-tiered UI system, in which workers who lose their jobs are entitled to UI benefits for a limited period after which they receive Unemployment Assistance (UA) benefits. The two-tiered UI system exploits the entitlement effect that was dis- cussed above as it provides the incentive to search more actively for those who are close to benefit exhaustion and for those not enti- tled to benefits (and , 2006a). Another mechanism to enhance the incentives to exit unem- ployment is to combine a declining sequence of benefits with a wage tax after reemployment, whereby the tax level depends on the duration of the unemployment spell. An increasing tax profile will encourage job finding by making prolonged search more expensive. In particular, the wage tax could be negative at the beginning of the unemployment spell representing a bonus for exiting unemploy- ment quickly (Hopenhayn and Nicolini, 1997). There are a number of theoretical considerations that are important regarding the optimal design of UI. Bilaga 9 till LU2011 determined through union-firm bargaining, a decreasing benefit schedule leads to wage pressure because it increases the welfare of the short-term unemployed at the expense of the long-term unem- ployed. When search effort is a choice of the unemployed worker a declining sequence of benefits is needed to encourage job search but the incentive effect will be weaker due to the wage pressure effect (Cahuc and , 2000). When the choice of effort determines not only the job finding probability through search effort but also the probability of remaining employed through the choice of work effort, then the optimal UI system might be non- monotonic. In the beginning of the unemployment spell the sys- tem should induce a large drop in consumption in order to discour- age shirking. This will affect the unemployment inflow. The time profile of benefits after the initial period should increase initially and then fall throughout the spell (and , 1996). The initial increase is similar to the re-employment bonus of a negative wage tax of Hopenhayn and Nicolini (1997) at the begin- ning of the unemployment spell followed by a declining sequence of benefits. Overall, the conclusion from this literature regarding the sequence of benefits suggests that a declining profile provides better incentives than a flat (or increasing) profile. The literature discussed so far on the optimal design of UI has considered models in which the unemployment agency can affect the consumption patterns of the agents through the sequence of benefits. This rests on the assumption that the agents cannot save and borrow without constraints from the market. Recent research has allowed for borrowing and savings, which means that the employment agency cannot influence the consumption profile of the unemployed worker through a declining benefit profile (e.g. Chetty, 2008; Pavoni, 2007; Shimer and , 2008). The optimal policy in this case is a benefit level that insures workers against unemployment risk, while their ability to dissave and borrow allows them to avoid transitory fluctuations in con- sumption (Shimer and , 2008). A declining sequence of benefits is needed to encourage job search and increase the unemployment outflow rate. As we dis- cussed above, workers can also affect their work effort and induce quits, which will affect the unemployment inflow. In order to dis- quits and shirking, the system should induce a large drop in consumption at the beginning of the unemployment spell. A waiting period before benefits are paid out is a way to discourage Bilaga 9 till LU2011 Another way to discourage quits is by providing benefits only to unemployed workers who were laid off and not to those who voluntarily quit their jobs. Unemployed workers may look for jobs, and once employed, may quit or induce a layoff quickly in order to upgrade their bene- fits. To prevent such cycles of unemployment spells with short intermediate employment spells eligibility criteria are important. The optimal policy should condition the benefits paid to unem- ployed workers on their employment history, such that the cover- age increases with the length of previous employment spells (Hopenhayn and Nicolini, 2009). In most existing UI systems eligibility criteria include a mini- mum employment period preceding the unemployment spell. When these criteria are not satisfied then the unemployed worker is either not eligible for benefits or may only receive the benefits not used in the previous unemployment spell. This section reviews the empirical evidence concerning the effects of unemployment insurance on the behavior of unemployed work- ers. As in the theoretical part, we consider separately the studies which focus on the unemployment inflow and outflow, and we review the evidence on the effect of UI on post-unemployment outcomes. The empirical literature on how UI affects the exit rate from unemployment is very large. The early literature focused mostly on the effect of the level of benefits using cross-sectional variation at the individual level. Benefit levels are generally found to have sig- nificant effects in U.S. studies, while most European studies find insignificant or weak effects.4 The disincen- tive effect of the benefit level on the exit rate from unemployment depends also on the spell duration, with bigger effects for the 4 Reviews of the early literature are given by and Micklewright, 1991; and , 1993. In most US studies the elasticity of unemployment duration with respect to benefit level is in the range 0.3 to 0.9 (, 1998). Bilaga 9 till LU2011 short-term unemployed (Nickell, 1979; Fallick, 1991). recently, a number of European studies have exploited policy driven changes in benefit levels. In some countries benefit levels were reduced (e.g. and ), while in others benefit levels were increased (e.g. ). The evidence from the evalua- tion of these reforms suggests that a reduction in the replacement rate increased re-employment probabilities, while an increase in benefit levels increased the duration of unemployment as individu- als with access to more generous unemployment benefits tend to leave unemployment less rapidly during the covered period.5 The research on the effect of benefit duration on the exit rate from unemployment is extensive both in the US and in Europe. One common finding of most studies is a sharp increase in the exit rate close to benefit expiration.6 In addition, an increase in the benefit duration creates significant disincentive effects. Unem- ployed workers react to an increase in benefit duration by changing the amount of search effort they exert in finding a job, which low- ers their exit rate from unemployment at the time before the change and moves the spike of the job finding rates to the new date of benefit expiration. Considering the effect of benefits by gender and age the evidence is less extensive with mixed results. Some studies find a larger effect for males while others find that women react more to changes in the benefit system.7 With respect to age the evidence suggests that older workers react more to an exten- sion of the maximum benefit duration than prime-age workers (Lalive, and Zweimüller, 2006). An important dimension in the optimal design of UI is to understand if any of the two main components of the benefit sys- tem – benefit level and benefit duration – matter more by affecting differently the behavior of unemployed workers. 5Carling, and Vejsiu (2001) for find that a reduction of the replacement rate from to in in 1995 increased the re-employment probabilities by about , with an elasticity of 1.7. and (2003) for estimated elasticities of around 0.95 for males and 0.35 for females. Lalive, and Zweimüller (2006) investigate policy changes in the replacement rate in in 1989. 6Studies for the US and include: , 1990; and , 1990; Card and , 2000; and , 2004; Ham and Rea, 1987. For Europe: Hunt (1995); , , Harkman and (1996); Winter-Ebmer (1998); Lalive and Zweimüller (2004); and (2003); and Vodopivec (2006); Lalive (2008); Lalive, and Zweimüller (2006). 7Winter-Ebmer (1998) investigates the effect of an extended benefit period in and finds a disincentive effect only for males, while and (2003) for find instead that the spike around the time of benefit expiration is larger for females than for males. Bilaga 9 till LU2011 dence suggests that both types of increase in the generosity of the UI system lead to longer unemployment duration. Consistent with the theory, most of the effect of the increase in benefit levels takes place early in the unemployment spell, while in the case of the extension of benefit duration most of the effect arises around the dates when benefits expired. In addition, older workers react more to the benefit duration extension than prime-age workers. The main conclusion from the empirical studies on the effect of the benefit system on the unemployment outflow is that a fixed benefit duration creates incentives to find a job, as the exit rate increases close to benefit exhaustion. This provides empirical sup- port to the theoretical analysis of the optimal UI with a declining sequence of benefits, which a two-tiered system represents. More- over, changes in the duration of benefits leads to stronger effects compared to changes in the level of benefits, which means that benefit duration is a more effective tool to influence incentives. One concern is that the quality of post-unemployment jobs is affected too. The higher exit rate from unemployment might be associated with jobs of lower quality and with higher probability of re-entering unemployment. We discuss this issue in section 2.2.3. The empirical evidence on the inflow into unemployment is rather limited. We discuss two dimensions. The first is the effect of eligi- bility rules on entrance into unemployment insurance. The second is how benefit level and benefit duration affect the inflow rates. Most empirical studies on the unemployment inflow effect of UI focus on the eligibility rules. The question is how eligibility for entrance into unemployment insurance affects employment dura- tion, the decision of workers to quit and the decision of firms to fire workers. The main conclusion is that the exit rate from employment to unemployment increases substantially as soon as the workers satisfy the number of weeks worked in order to qualify for UI benefits and at the point at which individuals have qualified for the maximum possible weeks of benefit receipts (e.g. Christofides and McKenna (1995, 1996); and Sargent (1998), for ). Moreover, the evidence suggests that changes in eligibility rules for UI have a significant impact on employment durations (e.g. and Riddell (1997) again for ). Bilaga 9 till LU2011 Employers play an important role in the adjustment of employ- ment durations by altering the timing of layoffs as many employ- ment spells that just qualified under the old system are extended to just qualify under the new system. As to the effect of the structure of the benefit system the existing evidence suggests that both the level and the maximum duration of benefits have a significant positive effect on the inflow into unemployment (e.g. and , 1997; Winter- Ebmer, 2003; Lalive and Zweimüller, 2004). Unlike the evidence for the effect of UI and in particular of benefit duration on the outflow rate, the evidence on the effect on post- unemployment outcomes is limited and mixed.