WE - Unemployment Insurance

Def. Unemployed (ILO)

1) do not work at the moment
2) are available to work
3) actively looking for work

UI parameters

1) level of benefits
2) duration
3) eligibility conditions

Level of benefits

replacement rate = UI benefits /previous earnings

Eligibility conditions

1) involuntary unemployment
2) previous work history
3) availability for work, job search

Can UI be handled without state intervention (free market) - 4 Conditions

1) Independent risks = ?
2) Probability less than 1 = yes
3) P known or estimable = yes
4) No adverse selection = no
5) no moral hazard = no

Adverse selection for Unemployment Insurance
Possible Solution

insurer could require information on previous employment record but imperfect

Adverse selection UI - Individuals

1) People with a stronger preference for leisure
2) People who know they will lose their job

Solution for Adverse selection UI

making UI mandatory

Moral hazard in UI - insured person

1) not put enough effort in keeping job
2) not enough effort in finding a job

Moral hazard in UI - employer

not put enough effort in avoiding lay-offs

Solution for moral hazard in UI for insured person

1) eligibility criteria
2) Job search requirements

Solution for moral hazard in UI for employer

experience rating

UI Redistribution

risks are distributed unequally over workers

UI insurance - equity concerns

more redistribution than risk-sharing

Key trade-off UI

insurance vs incentives

optimal drop in consumption (formula)

Incentive effect of UI divided by risk aversion

Incentive effect of UI

What is the influence of the UI system on unemployment duration
= empirical question

Risk aversion in Unemployment insurance

value of insurance
= normative or empirical question

Value of unemployment insurance for individual

willingness to substitute between income when employed and when unemployed

Value of unemployment insurance for society

willingness to redistribute from low-risk to high-risk groups, from high incomes to low incomes

Value of unemployment insurance for society - type of question

How much more do we value additional income for poorer vs. for richer households?
= Normative question

Value of unemployment insurance for individual - type of question

How much do people value insurance?
= Empirical question

Why is there unemployment - static labor market model

cannot explain involuntary unemployment

Alternative theory to explain unemployment

Job search theory

Job search theory

it takes time to find a job
= frictional unemployment

Job search theory - trade off for unemployed person

expected value of taking the job VS remaining unemployed

Influences on probability of unemployment

1) Job arrival rate
2) Job acceptance rate

What affects the Job arrival rate

1) search efforts
2) Business cycle, state of the labor market

What affects Jobs acceptance rate

1) reservation wage
2) wage distribution of job offers

What affects both search effort and the reservation wage

benefit level and duration (negative and positive, respectively)

Effect of benefit level in theory (both channels)

higher benefit level >
1) higher reservation wage = lower job acceptance
2) lower search effect = lower job arrival rate

Effect of benefit level in theory (short)

individuals stay unemployed longer

Effect of benefit entitlement period in theory

as UI benefits proceed over time, higher risk of benefits exhaustion

Effect of benefit entitlement period in theory (two channels)

1) as benefits decrease = reservation wage decreases = higher job acceptance rate
2) shorter duration = higher search efforts = higher jobs arrival rates

UI and recessions

less jobs
= less moral hazard, more insurance needed
= Search externalities

How to measure effects of UI

1) looking at two key parameters
2) cross-sectional or natural experiments

In theory - generous UI means ..

1) longer unemployment spells
= better job matches = better job quality
= more skill depreciation = worse job quality

In empirical world - generous UI …

not clear if better job matches trumps less skill depreciation

Spike effects in unemployment insurance

at the end of benefit entitlement, large increase in share of people who leave UI

Spikes and Job search theory

= cannot be explained by job search
theoretically should be smooth dropping out rather than a bunch at once

Potential reasons for spikes

1) Hyperbolic discounting (procrastination)
2) timing new contract at the moment of benefit exhaustion
3) are people dropping out of labor force entirely

Measuring willingness to pay for UI

not possible since participation is mandatory

Types of Active Labor Market Policies

1) Training
2) Subsidized employment
3) Public employment services
4) Activation

Subsidised employment

1) Wage subsidies to employers
2) Direct public employment

What are ALMPs for?

1) Enhance worker productivity
2) Bridge the productivity gap
3) Improve job matches
4) Promote active job search behaviour, test availability for work

AMLP - Enhance worker productivity

1) Lack of access to credit to finance re-training
2) positive externalities of retraining

ALMP - Bridge the productivity gap

Positive externalities of employment

ALMP - Promote active job search behaviour

provide incentives through other channel than benefits

Less desirable effects of ALMPs

1) Lock-in effect
2) Crowding out of jobs or other job seekers

Effects of ALMPs on employment

more positive effects during recessions