The unemployment insurance trade-off

After a long fight Congress recently extended unemployment benefits for the long-term unemployed. Nevertheless, the debate exposed a fascinating discussion in economics. It also highlighted the need to avoid simplistic economic concepts.

The economic argument against extending the nation's unemployment benefits is simple: Increasing the length of unemployment benefits has the perverse effect of increasing a spell of unemployment. The opponents aren't hard-hearted. It's simple economics.

Here's how Arthur Laffer, chairman of Laffer Associates and a leading supply-sider, illustrated the idea on the editorial page of the Wall Street Journal:

On the face of it, the idea that higher unemployment benefits won't lead to more unemployment doesn't make much sense. Imagine what the unemployment rate would look like if unemployment benefits were universally $150,000 per year. My guess is we'd have a heck of a lot more unemployment. Common sense and personal experience indicate higher unemployment benefits will make unemployment less unattractive and thereby increase unemployment even in the Great Recession.

But the idea is anything but simple, even though most economists would agree that logic suggests a trade-off. (However, no one is making $150,000 on unemployment insurance--far from it.) But a new generation of economic research suggests the impact is relatively small. For instance, a 2000 study by economists David Card and Phillip Levine found that a 13 week extension leads to a one week increase in the average number of weeks of unemployment insurance collected by workers.

Even more important when thinking through an economic question like this is to weigh the costs against the benefits. For example, unemployment insurance allows families to keep up their consumption; the unemployed tend to spend most of the money they get, a boost to the economy in times of trouble; and unemployment insurance allows workers to search for a job that fits their skills better than simply settling for anything that pays. Harvard University economist Raj Chetty offers a slide show that goes through our existing knowledge of the trade-offs when it comes to unemployment insurance.

For example, he highlights a single earner with children and no savings. Without any unemployment insurance the parent is forced to make difficult choices to put food on the table and pay the bills, perhaps spending little time with her children or skipping medica their medical appointments. For this parent, unemployment insurance will increase the length of unemployment as she chooses to spend more time with children and to search more efiiciently and patiently for a good job. But this increase in duration is not a negative effect generated by distorted work incentives. It's a net benefit of having more cash on hand.

Here's the net result, according to Chetty:

*Evidence shows that even in normal times the benefits of unemployment insurance are large relative to work disincentive costs

*The benefits of unemployment insurance are likely to be larger in this deep, long recession. That's especially true for the long-term unemployed because of depleted assets, the collapse of credit markets, and risk of foreclosure

*The work disincentive effect of unemployment insurance is likely to be smaller than usual now with the great recession and slow recovery. People likely to take any job they can get.

*So, weighing costs against benefits, extending unemployment insurance further in current economy would significantly increase economic welfare

In other words, economics says Congress did the right thing and isn't stimulating joblessness. .

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