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Does Unemployment Insurance lead to longer Unemployment Duration?

Updated on February 13, 2016

Introduction

Unemployment insurance has become an important part of the social welfare system. While working, workers face the inherent risk of getting laid off and becoming unemployed. The risk can be disastrous to the workers as well as their family, and can potentially pose negative social externalities. Hence, the need for an unemployment insurance program emerges to reduce the impending unwanted consequences of being unemployed and to maintain workers’ ability to consume. Unemployment insurance is also believed to act as a macroeconomic stabilizer to lessen the effects of reduction in consumption caused by unemployment especially during recessionary time.

Source

Overview

The relationship between unemployment benefit and unemployment duration has been of great interests among labor economists and policy makers. Despite its popularity, unemployment insurance programs have been under attack because of their adverse effects on workers’ incentives to reenter the employment force. Similar to other insurance programs, moral hazard is likely to accompany unemployment insurance, leading to abuses of the program. The hypothesis is that an increase in unemployment benefits will likely increase the duration of time in which a worker remains unemployed. The argument is not new. Since unemployment insurance reduces the cost of being unemployed, it raises workers’ reservation wage to induce them to accept a job offer. Unless the after-tax income earned from the job is significantly higher than unemployment compensation, workers might prefer not working, and continuing their job search.

History of US unemployment insurance
History of US unemployment insurance | Source

Overview of the unemployment compensation program in the United States

In the United States, unemployment insurance was first started nationally as the result of the Title III and Title IX of the Social Security Tax of 1935. It is a jointly-coordinated federal and state program, in which the federal law provides general guidance, and each state tailors the rule accordingly to its own needs. According to the rule, a uniform tax on payroll is imposed on employers who employ more than 8 workers for more than 20 weeks in a calendar year. All the contributions are collected and deposited in the unemployment trust fund of the Department of the Treasury. Each state has its own account to the fund, and can only withdraw money to pay for the unemployment benefit claims.

In order to file a claim for unemployment insurance, workers have to demonstrate that they are able and available to work. They must have been in employment and only out of employment because of the lack of work, not because of their own faults such as misconduct behaviors. While receiving the benefits, they must show that they actively seek for jobs or engage in activities that improve their chance of getting reemployed.

Since its introduction, some changes have been made to the program to reduce abuses to the program or to accommodate some certain circumstances. During expansionary time, contributions to the Unemployment Trust Fund rise because more jobs are created, and less workers claim for unemployment. Vice versa, during recessionary time, more people apply for unemployment benefits, injecting the flow of unemployment benefits into the economy. The government sometimes has to extend the benefit claim period for workers who exhaust their entitlement to regular benefit but still cannot find a job. Unemployment insurance taxation rate is also lower over recessionary time and period of high unemployment rate. The great recession in 2008 witnesses a lot of changes made to the unemployment insurance system. The average benefit period increases from 6 months to a year depending on the states. The federal law also allows state to extend the payment period for the benefits.

Graph 1: Unemployment duration and weekly initial unemployment claims
Graph 1: Unemployment duration and weekly initial unemployment claims | Source

Some statistics and figures

The relationship between unemployment benefit and unemployment duration has been of great interests among labor economists and policy makers. Graph 1 shows the weekly unemployment claims and unemployment duration from 1967 to September 2014. The weekly initial unemployment insurance claims are collected by the Bureau of Labor Statistics. All data are seasonally adjusted to even out the impacts of seasonal fluctuations. The unemployment duration is measured as the average aggregate number of weeks being unemployed at a certain time. The data shows that over the period of more than 30 years, the average length of unemployment duration has increased almost 4 times. The total benefit payment rises in almost all episodes of recession. The year 2009 marked an unprecedented increase in the federal payment of unemployment benefit of 1638 billions, almost tripling from 2008, and dramatically above the average of 300 million dollars a year. These disturbing statistics characterize the magnitude of the 2008 recession and pose challenges to policy makers to be able to forecast and accommodate the program during an unexpected economic disaster.

Graph 2: Unemployment claims and unemployment rate
Graph 2: Unemployment claims and unemployment rate | Source

Graph 2 shows that unemployment rate also seems to increase and fall consistently with weekly claims of unemployment benefits, averaging around 6 percent a month over the sample period. There are 7 episodes of recession, and all are characterized with high unemployment rate. The number of claims is highly correlated with the total amount of unemployment benefit, but not significantly impacts the duration of unemployment.

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Experts' opinion

Mortensen (1977) develops a theoretical dynamic model in which individuals attempt to maximize their utility which is a function of income and leisure, and individuals consume all of their income. He measures how the implementation of unemployment insurance changes a worker’s decision to accept a job and end their job search period. He argues that although a number of published researches conclude a positive relationship between unemployment benefits and unemployment, the effect of unemployment benefits on unemployment duration is ambiguous. On one hand, those who currently benefit from unemployment compensation might decide to stay unemployed longer to search for a better job offer. On the other hand, although unemployment insurance lessens the pain of being unemployed, the benefits are not enough to maintain workers’ usual level of consumption. Besides, unemployment insurance makes employment even more attractive for those who currently do not qualify for unemployment insurance such as new entrants, and job quitters. They expect that they will be able to receive the compensation at a future point in time, which increases the benefits of being employed. Hence, they might lower their reservation wage, and search for job more intensively. The two effects of unemployment insurance offset each other, leaving the net effect on unemployment duration indeterminable. In fact, the second effect may even dominate for workers who are at the end of their benefit period or have used up all of the benefit receivables (Mortensen, 1977).

Steps to apply for unemployment benefits

  • Contact state unemployment agency to find out if you are eligible to receive unemployment insurance: The most important criteria is that you have to become unemployed through no fault of your own, and you are available and willing to work
  • Initiate the application process
  • Gather necessary information and documents: You usually need to provide your personal information, your previous employers’ information, the reasons for being unemployed, and evidence of your job search efforts
  • Submit the completed application: The process usually takes from 7 to 10 business days
  • Fill out continued unemployment insurance claim and other necessary documents
  • Keep searching for jobs

Along the similar line of reasoning, Lancaster concludes that it is possible to derive useful estimates from the effects of unemployment benefits on the aggregate level of unemployment duration. However, it is impossible to estimate the variation in each individual’s decision to return to work over their unemployment period since his or her reservation wage changes over time (Lancaster, 1979). Meyer finds that higher unemployment benefit has negative impact on the probability of leaving unemployment. However, the probability of leaving unemployment increases considerably just before when the benefit period ends. From 6 to 2 weeks until exhaustion the probability of leaving rises 67 percent, and 1 week away it rises an additional 97 percent (Meyer, 1998). Since the duration of benefit allowance is fixed by regulation, it is a very risky strategy for workers to wait until exhausting the benefit period to accept a job offer. In addition, Social norms also pressure workers into quickly finding a job because being unemployed is usually perceived as “being a loser”.

Looking from a different perspective, Grubel, Maki and Sax claim that the introduction of unemployment insurance benefits changes the relative cost of work and leisure, lowers costs of job search, prolongs waiting period, and induces workers to make false documentation of their search efforts. For their empirical analysis, they employ a time series data covering the period 1953—72 and classify unemployment into three categories: structural unemployment, cyclical unemployment, and seasonal unemployment. Structural unemployment is a constant that changes only slightly, cyclical unemployment is functionally related to an index of economic instability such as the growth rate of GNP. They find a positive relationship between unemployment benefit and unemployment duration, and the elasticity of the unemployment rate with respect to the ratio of benefits to wages, measured at the point of means, is 0.69 (Grubel, Maki, & Sax, 1975).

Why unemployment insurance prolong unemployment duration
Why unemployment insurance does not impact unemployment duration?
Compensate people for not working
Make employment more attractive for those who do not qualify
Support people to remained unemployed longer to search for a better job
Fixed duration of benefit allowance
Increase a worker's reservation wage
Social pressure
Change relative cost of work and leisure
Desire to maintain pre-unemployed consumption level
Lower costs of job search
Harder to find a good job if remained unemployed too long

Conclusion

In conclusion, although there has not been a concrete conclusion to support the moral hazard accompany unemployment insurance story, moral hazard should not be completely ignored. However, while seeking for a way to reduce abuses to the unemployment insurance program, policy makers need to take into account the role of unemployment insurance as a macro-economic stabilizer to help the economy recover from a recession. There can be some optimal amount of unemployment insurance, which lessens the shock of being unemployed by workers, but also induces them to actively seek jobs (Meyer, 1998). While there are costs inherent to the program, the economic welfare and social welfare generated by the program are significant, especially during the current economic atmosphere.

President Obama on Strengthening and Modernizing the Unemployment Insurance System

Works cited

(1997, July). Social Security Programs in the United States . SSA Publication No. 13-11758.

Chimerine, L., Black, T., & Lester, C. (1999). Unemployment Insurance as an Economic Stabilizer: Evidence of Effectiveness Over Three Decades. Coffey Communications, LLC.

Engen, E., & Gruber, J. (2001). Unemployment Insurance and Precautionary Savings. Journal of Monetary Economics , 545–579.

Grubel, H., Maki, D., & Sax, S. (1975). Real and Insurance-Induced Unemployment in Canada. The Canadian Journal of Economics , 174-191.

Lancaster, T. (1979). Econometric Methods for the Duration of Unemployment. Econometrica , 939-956.

Mehdi, S., & Wunava, P. (1994). The Effect of Unemployment Insurance on Unemployment Rate and Average Duration: Evidence from Pooled Cross-sectional and Time-series Data. Applied Economics Letters , 114-118.

Meyer, B. (1998). Unemployment Insurance and Unemployment Spell. NBER Working Paper Series .

Mortensen, D. (1977). Unemployment Insurance and Job Search Decisions. Industrial and Labor Relations Review , 505-517.

Osberg, L. (1993). Unemployment Insurance and Unemployment -- Revisited. Unemployment: What is to be Done? Ontario.

Wolff, E. (2005). Computerization and Rising Unemployment Duration. Eastern Economic Journal .

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    • honghanhvt1182 profile image
      Author

      Hanh Vu 3 years ago from Danang, Vietnam

      Hi, Thank you very much for your comment! I do appreciate your opinion and thanks for taking time reading the article. I'm glad that you find the information useful somehow. Although issues with unemployment insurance claim are not too great now as compared to a few years ago, I think it is still important to keep it in mind so we can make appropriate changes to the system and won't have to face the same problems later.

    • bmguy621 profile image

      Daniel 3 years ago from Maryland

      Great article and I agree with your conclusion, while it doesn't appear conclusory we should not ignore the incentives it creates...tough issue with good arguments on both sides I think, thanks for the information!