Friday, April 16, 2010

Thoughts from Keynes and Kuehn on Unemployment Insurance

The President recently signed an extension of unemployment insurance, so I thought it was a good time to share a somewhat surprising view of John Maynard Keynes on this sort of program. In the General Theory (1936), he wrote:

"It is curious how common sense, wriggling for an escape from absurd conclusions, has been apt to reach a preference for wholly 'wasteful' forms of loan expenditure rather than for partly wasteful forms, which, because they are not wholly wasteful, tend to be judged on strict 'business' principles. For example, unemployment relief financed by loans is more readily accepted than the financing of improvements at a charge below the current rate of interest; whilst the form of digging holes in the ground known as gold-mining, which not only adds nothing whatever to the real wealth of the world but involves the disutility of labour, is the most acceptable solution of all."

Of course, Keynesians have since reconciled themselves to unemployment insurance, but I thought this was an interesting objection from Keynes. And a very insightful first couple sentences on the irrationality of politicians.

I've generally been in support of strengthening unemployment insurance, but I find the concern about its impact on the unemployment rate to be valid - and it's something that increasingly concerns me as we continue to extend the program. My all-time favorite sentiment on unemployment insurance is from Martin Baily, who wrote that "unemployment may increase as a result of UI, but it matters less". We have to look at the impact on the unemployment rate as a trade off. Unemployment may increase with more generous benefits, but the discussion can't stop there. How does quality of life change as a result of the benefits? How important are the benefits for counter-cyclical spending and macro-stabilization? I'm getting increasingly leery of all these extensions - American unemployment insurance is beginning to look like the European safety net. But we have to be careful about too heavily emphasizing the impact on unemployment rate when the hiring rate is so abysmal. If hiring were stronger, pointing to unemployment insurance as the culprit might be more convincing. For now, it's on my radar but it's hard to get too upset about it. But if I had the choice between another extension or a stronger infrastructure spending bill plus a hiring tax credit, I'd choose the latter over more extensions to UI in a heart-beat.

I also wanted to share this Wall Street Journal piece that makes an important point about the benefits of a robust UI program. In this job market, job seekers jump on any offer that's made to them, regardless of whether it's the right match long-term. That's what's best for them now, but it could be trouble down the road. We want the right employer-employee matches made, and this article suggests that unemployment insurance can help provide the breathing room to make that match. If those matches are made out of recessionary desperation, you could see what Austrians call "malinvestment" of human capital, and what Arnold Kling has called a "recalculation" down the road when the mistake is revealed.

Life is full of trade-offs, and the unemployment insurance program is no exception. Decisions around this program are tough at a time like this - particularly after it has already been repeatedly extended. It's important to be honest about all the costs and all the benefits.

4 comments:

  1. The trouble is with the magnitudes of costs and benefits. As a theoretical matter, we know these magnitudes exist, but we can't just just pull out a tape measure, and our other tools are not much better.

    The range of possibilities is great and we have little in the way of means to wittle aaway at them. Inevtiably, political interests will end up making the decision, and in that case we probably would have been better off using the tape measure.

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  2. I know we have pretty consistent estimates on what it does to the employment rate - Summers and I believe Bruce Meyer have done a lot of work on that. I know a colleague of mine was doing work on the countercyclical impact of unemployment benefits as far back as the sixties - I'm confident there's been only more work on that done since then. I just finished producing some figures for this guy the contribution of UI benefits to getting families out of poverty. There's all sorts of other studies on how UI impacts families' quality of life. What exactly is at tape-measure level that you're thinking of?

    Now - what is in a black box of sorts is how people value these different things. Maybe some people prefer a more erratic business cycle to somewhat higher unemployment rates. These valuations of the tradeoffs are harder to get at. But then again, that's what we have representative government for, isn't it! :)

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  3. I think of UI as a special insurance contract that pays in proportion to the intensity and duration of the rain. The contract is a bit odd, in that only a certain portion of it is guaranteed. The rest is provided only if Congress says so. But Congress usually extends the benefits when the rain is hard and long, so the policy is still a good bet. Politics, after all, is just economics continued by other means.

    UI almost certainly creates some moral hazard. But so does all insurance. The issue is whether the insurer can price for the additional risk, i.e., whether UI is suppressing the supply of labor in a way that make its provision pro-cyclical. If UI doesn't make the supply of available labor inadequate, it just changes the mix of potential hirees, probably for the better!

    The moral hazard associated with UI also reflects the reality that unemployed people live on savings and UI. When the savings run out, UI is probably enough to keep people from seeking work.

    Many economic positions are stated as binary propositions, but they are really estimates of analog quantities, estimates that may be too high or too low. In assessing such positions, we have to examine the stakes of their being wrong in either direction, and especially the cost of remedying any damage that acting wrongly in either case may do.

    In this context, I believe it is relevant that UI cannot break the bank. Congress can stop the benefits whenever evidence suggests that they are counterproductive. But if people are without work and UI, and they cannot shop, not only do they starve or steal, but the counter-cyclical effect of UI is lost. The businesses that would sell to UI recipients fail, too, and Congress cannot vote them back into business or their employees back to work.

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  4. Very interesting quotation from Keynes. I think the present political discussion is more about the length of the unemployment insurance benefits than the existence of unemployment insurance. How long should they go on? With the economy seeming to revive should we continue to provide incentive to continue search or idleness? At some point the distributional benefits (if there are any) are outweighed by the efficiency losses.

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