Economics: Unemployment Insurance

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You know, we've been talking about unemployment as if it were the weather, as if it were just some natural force that descends upon you and you passively respond to it. And yet, unemployment persists, depending on choices that people make. If I want to go to work faster, I'm going to work harder to go out and find a job. I'm going to read the newspaper, I'm going to distribute my résumé, I'm going to make phone calls; I'm going to try to persuade people to hire me. And the amount of effort that I expend to try to get a job is influenced by how badly I want one. And how badly I want a job is influenced by the difference between the money I earn without a job and the money that I earn with a job. So choices that individuals make can either cause unemployment to be more protracted, or it can cause it to last less long.
Most people are unemployed for short periods of time, but sometimes people are unemployed for longer periods. In any case, we want people to have an incentive to go out and find a good job as soon as possible, so that they can once again be productively contributing to society and the economy.
Now, your decision about whether to go out and look for a job right now or not is in some measure influenced by how well you're doing without a job. And one of the things that supports you in a period of unemployment is unemployment insurance. Most people who are unemployed are entitled to collect up to 50% of their previous salary for up to 26 weeks. That is, when you're unemployed, you're not suddenly desperate. You may not have to go out and immediately get another job just to pay the rent or feed yourself, because you have this reserve that you can only collect in the event that you're fired from your job, or your company closes, and you're out of work.
So people who are involuntarily unemployed are eligible for unemployment insurance, and unemployment insurance makes their life better; it keeps them from being desperate. On the other hand, it influences their incentives, and may cause them to delay their job search, because they don't have to get a job right away. This is a general problem with all kinds of insurance, a problem we call moral hazard. Anytime a person is insured, they are going to exert less effort to mitigate the risks for which they originally bought the insurance.
Let me give you an example. I have insurance on my house; therefore, since my house and all of the possessions in it are insured by the insurance company, I'm less inclined to close my windows when I leave the house to go to work for the day. That's because if a burglar breaks into the house, the insurance company is just going to replace anything that the burglar takes. You see, because the risk is mitigated, because the risk and the cost of managing the risk is borne by the insurance company, I don't work as hard to control the risk.
Now, about unemployment insurance - people who are unemployed begin a search process to find a new job. And a search process is costly. It means I've got to get up in the morning, I've got to get cleaned up, I've got to go distribute my résumé, I've got to knock on doors, I've got to make phone calls. All of that takes time and effort, and as long as I'm drawing a check, I have less incentive - that is, I'm less fearful - of winding up in a desperate situation; I may not work quite as hard.
Now, states that have done experiments - paying workers to find work quickly - find that, in fact, those workers are more rapidly employed than workers who are collecting unemployment insurance with no incentive to get employed quickly. And, if you think about it, that makes sense; people usually do respond to monetary incentives, and do whatever they get paid more to do.
The natural rate of unemployment grows to about 6% in the 1960s and `70s, at about the same time as unemployment insurance was extended to cover more and more people in the economy. Once again, people are responding rationally to the incentives created by unemployment insurance. Once you don't have to worry so much about losing your job, and once you're protected and cared for by the insurance payment during the period of unemployment, you're going to be a little bit less desperate and not work quite so hard to find employment.
So how can we design a system that gives us the benefits of the protection of unemployment insurance without the negative incentive consequences that cause people to stay in unemployment longer than they otherwise would? How can we protect people without creating a whole lot of moral hazard? Well, a couple of proposals are that, first of all, we create a two-tiered system to distinguish between short-term unemployment and long-term unemployment. Short-term unemployment, we can allow this insurance program to give workers time to find a job and reemploy their skills somewhere else. But don't make it last so long that they don't have the incentive to go out and find new work.
For workers that are structurally unemployed - who lose their job in a factory and now are going to have to acquire new skills - we might need a different kind of unemployment insurance, one that only pays workers who go and are involved in training programs, or vo-technical education, or something that retools their skills to prepare them for a new job. That is, we want the unemployment insurance system to continue to provide good incentives to people to go out and search for a job.
In some cases, we might only pay unemployment insurance to those people who are actively engaged in the search process. That's going to be hard to monitor though, isn't it? I mean, how do we tell who's looking for a job and who's not? But unemployment insurance programs that provide coverage for shorter periods of time, although they are probably going to produce more stress among us workers when we get unemployed, are going to increase our incentives to stay unemployed for shorter periods of time, and work harder to find a job quickly.
But those workers who find themselves unemployed for longer periods of time because of events beyond their control - such as an industry becomes uncompetitive, or new technology puts them out of a job - those workers need a different kind of insurance program that directs their efforts towards creating new human capital, new skills that are going to make them more employable in the long term. Unemployment insurance, like any insurance program, creates moral hazard, and probably a fair bit of the persistence of unemployment is due to people not moving really fast to find a new job, because they're not especially worried, because they're insured. We could redesign an insurance scheme that provides a high level of protection, but also rewards employees whenever they work harder to search to find new productive employment, instead of succumbing to moral hazard.
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Causes of Unemployment
Unemployment Insurance Page [2 of 2]