Economic Effects of the Unemployment Insurance Benefit

By Fujita, Shigeru | Business Review (Federal Reserve Bank of Philadelphia), Winter 2010 | Go to article overview

Economic Effects of the Unemployment Insurance Benefit


Fujita, Shigeru, Business Review (Federal Reserve Bank of Philadelphia)


The U.S. labor market has remained weak in recent years, even though the overall economy itself has started to grow again after the deep recession. For example, in the fourth quarter of 2009, the average unemployment rate was at a double-digit level, a level we have not seen since the early 1980s, even though real GDP grew by more than 5 percent. One of the main policy reactions to painful developments in the labor market has been the expansion of unemployment insurance.

The unemployment insurance (UI) system constitutes one of the major components of the social security programs in the U.S. (1) It provides income (and thus consumption) protection for those who have lost their jobs involuntarily. During "normal" times, unemployment insurance benefits are provided through the regular unemployment compensation (UC) program, which is funded and administered at the state level. Regular benefits, which are paid weekly, replace 50 to 80 percent of pre-unemployment earnings and last 26 weeks in the majority of states. (2) During economic downturns, however, the federal government often provides additional support by extending UI benefits. Especially in the last few years, the U.S. government has greatly extended the duration of benefits as a means to combat the surmounting joblessness. As of the summer of 2010, unemployed workers who reside in states with a relatively high unemployment rate are entitled to receive UI benefits up to 99 weeks (26 weeks of regular benefits and 73 weeks of extended benefits).

Given the painful nature of job losses, the merits of UI benefits are often taken for granted in public policy discussions. In this article, I will review some of the academic literature on the economic effects of UI benefits. This is useful for evaluating the expansions of the UI system in recent years.

First, UI can improve people's well-being because it helps them avoid large drops in consumption in the face of job losses: The government provides an insurance against job loss. There is, however, a concern that it might produce an adverse effect on the incentive to look for a job. That is, UI benefits could cause job seekers to put less effort into searching for a job, consequently raising the unemployment rate. Some researchers have argued that this incentive effect is large, given the observation that the rate of exit from unemployment at the time of expiration of UI benefits increases noticeably. An important issue here is that the increase in the exit rate from unemployment can be driven by the fact that the worker is simply dropping out of the labor force, thereby losing eligibility for UI benefits. This phenomenon can complicate the interpretation of the incentive effect. Other researchers also point out the possibility that UI benefits enhance a firm's incentive to create more jobs. Below, I will lay out these arguments in detail.

Before getting into the detailed discussion, let's first briefly review recent developments regarding UI benefits and the U.S. labor market.

UNEMPLOYMENT INSURANCE DURING THE GREAT RECESSION

As mentioned above, regular unemployment insurance benefits typically last 26 weeks. However, the federal government often enacts extensions of UI benefits during economic downturns. There are two types of federal emergency programs. The first is called the extended benefit (EB) program, which is permanently authorized, meaning that the extension is triggered automatically whenever the state unemployment rate reaches a certain level. It provides additional weeks of unemployment benefits up to a maximum of either 13 weeks or 20 weeks, depending on the state.

The second type is a federal program that Congress enacts temporarily during downturns. The latest program of this type, the Emergency Unemployment Compensation program (EUC08), represents the eighth time Congress has created such a program. (3) EUC08 was signed into law in June 2008.

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