Our objective in this paper is to assess the effect of unemployment benefit extensions on employment. Measuring the magnitude of this effect is manifestly important for understanding the economic consequences of this widely used policy instrument. Yet, the existing literature provides little information on the size, let alone the sign of this effect.
In the theoretical literature the effect of benefit extensions on employment is generally ambiguous. Basic decision theory suggests that some unemployed may increase their search effort in response to a cut in benefits, while others, who were mainly searching to qualify for benefits, might drop out of the labor force once losing eligibility, leading to offsetting effects on employment. Equilibrium job search theory typically implies a positive effect of a cut in benefit duration on job creation. This makes it easier to find jobs and might induce those previously out-of-labor force to rejoin the labor force, leading to an increase in employment with an ambiguous effect on unemployment since the number of job vacancies and the number of searchers increases at the same time.
The empirical micro literature has focused virtually exclusively on measuring the effects of benefit eligibility on the search effort of unemployed workers – a focus that is too narrow to infer the impact of benefit duration on employment. The estimates in the quantitative macro literature vary widely depending on the value of parameters, which are notoriously difficult to identify. Moreover, the literature generally ignores the effect of policies on participation decisions of those out-of-the-labor force, which limits their ability to measure the total effect on employment. Indeed, in the data the flow from non-participation into employment accounts for over 60% of all transitions into employment.
A simple descriptive analysis shows a much faster employment growth in 2014 in high benefit states prior to the reform relative to their low benefit counterparts. The same finding holds if we compare the employment growth in counties that belong to high benefit states relative to their neighboring counties that belong to states with lower benefit durations prior to the reform. The implied magnitude of the negative effect of benefit duration on employment is so large that it can account for almost the entire remarkable employment growth experienced by the U.S. in 2014.
Our formal econometric analysis tackles the key challenge of precisely measuring the coun- terfactual employment growth that various locations would have experienced without a cut in benefits. Our formal measurement approach continues to rely on the comparisons of counties that border each other but belong to different states. However, the effect of the benefit cut is estimated alongside with a flexible specification of the difference in trends between border counties in each pair using an interactive effects model. We find that after controlling for these heterogeneous employment trends, changes in unemployment benefits continue to have a large and statistically significant effect on employment: a 1 percent drop in benefit duration increases employment by 0.0161 log point. In the aggregate, our estimates imply that the cut in benefit duration accounted for about 61 percent of the aggregate employment growth in 2014.
While we did not impose any theoretical restrictions of a particular labor market model on our empirical analysis, the findings are consistent with the standard equilibrium labor market search model. For example, the primary labor market effect of a cut in unemployment benefit duration in the framework of Mortensen and Pissarides (1994) is the positive impact on job creation. It is this rise in job creation that leads in equilibrium to the increase in employment.
Another important finding in this paper concerns the effect of unemployment benefit dura- tion on labor force participation. Prior to the reform, the consensus in the profession seemed to predict a negative impact of the cut in benefit durations on the size of the labor force. Instead, we found that the reform led to almost a million non-participants entering the labor market. It seems plausible that they were encouraged by the improved probability of finding jobs due to the positive effect of the reform on job creation.
It seems quite remarkable that, despite their clear importance, the aggregate labor market implications of unemployment benefit policies have been virtually unexplored in the empirical literature. This gap in knowledge seems limiting not only for our ability to develop good economic theories but also for making sound policy choices. For example, unemployment benefit extensions are routinely used for the purposes of macroeconomic stabilization. Yet, the findings in this paper imply that the negative effects of unemployment benefit extensions on employment far outweighs the potential stimulative effects often ascribed to this policy. It appears important to take these effects into account.
Chosen excerpts by Job Market Monitor. Read the whole story at The Impact Of Unemployment Benefit Extensions On Employment: The 2014 Employment Miracle?
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