A Prime Stabilizer: Unemployment Insurance

Article excerpt

It is often said that unemployment insurance is the first line of defense in a recession. The line needs some strengthening, however, because the program has not kept up with changes in the work force and has been neglected by many state legislatures.

Economists have a well-worked-out theory of unemployment insurance. The program helps laid-off workers maintain consumption and search for a job that matches their skills. But these benefits come at a cost: More generous or longer-lasting benefits reduce the intensity with which unemployed workers look for a job.

To balance these intended and unintended effects, most states replace only 40 percent to 50 percent of lost wages. Benefits are also temporary, typically lasting up to 26 weeks. And through a financing system known as experience rating, employers who lay off workers more frequently pay somewhat more into the program.

This is a distinctly American brand of unemployment compensation. In France, for example, benefits replace around 80 percent of earnings and last up to two years, and there is no experience rating. The relatively low level and short duration of benefits -- and the experience rating -- partially account for the lower U.S. unemployment rate.

Unemployment insurance is the quintessential economic stimulus: Benefits ramp up temporarily in a downturn and are aimed at those most in need. Outlays soared from $14 billion in 1989 to $37 billion in 1992, when the jobless rate peaked, and fell to $21 billion in 1995, when the labor market improved. By building up reserves in prosperous times and spending them in weaker times, the program helps stabilize the economy.

Unlike many other programs being considered for the stimulus package, unemployment insurance also provides security for those who do not directly receive benefits. Just knowing that benefits are available in case of a job loss inspires confidence. A strong safety net system also makes it unnecessary to have industry-by-industry bailouts in response to adverse shocks.

President Bush recently proposed spending $3 billion to extend unemployment benefits by 13 weeks for eligible workers. Extended benefits are a sensible and traditional response in a recession. The distortion caused by longer-lasting or more generous benefits is less significant in a downturn because jobs are less plentiful regardless of how hard people search for work, said Dale Mortensen of Northwestern University, who has done pioneering research on unemployment insurance.

A bipartisan group in Congress is questioning whether Bush's proposal goes far enough to mend the program, as well as the particular way Bush would extend benefits.

In the president's proposal, benefits would automatically be extended in Virginia, New York and New Jersey, and in other states in which the jobless rate rises 30 percent, but only for those who lost jobs after Sept. 11.

But this trigger mechanism has some peculiar implications. If the unemployment rate rises from 3 percent to 4 percent in one state, extended benefits will kick in, but if it jumps from 10 percent to 12.5 percent in another, that state will not qualify.

It is also unclear why Virginia, which has an unemployment rate of 2.9 percent, the nation's third lowest, should qualify for extended benefits, while Washington -- which is right next to the Pentagon and has a 6. …