Academic journal article The Economic and Labour Relations Review : ELRR

Unemployment and the Structure of Unemployment Benefits

Academic journal article The Economic and Labour Relations Review : ELRR

Unemployment and the Structure of Unemployment Benefits

Article excerpt

1. Introduction

In order to investigate the relationship between the level of unemployment benefit relative to some measure of average earnings and the level of unemployment it is useful to set out a simple relationship. This is that the level of unemployment is determined by both the magnitude of the flows of people into unemployment, and out of unemployment and by the average period of time which elapses between the two flows. In a static labour force the unemployment rate, U, is given by

U = I/L x D,


I: inflows to unemployment

L: labour force

D: average duration of unemployment and where I and D are measured in the same units of time.

From the above identity it is evident that the level or structure of unemployment benefits, or the way in which the benefit system is administered, may influence the level of unemployment by affecting the inflows to unemployment and/or the average duration of unemployment.

The purpose of this note is to briefly survey the empirical evidence on this issue. (A very comprehensive survey of the literature is provided by Atkinson and Micklewright, 1991.) While some relevant empirical work has been undertaken in Australia it is necessary to make reference to overseas studies. Fortunately the main conclusions to be drawn seem to be fairly clear and the recommendations made by the Committee on Employment Opportunities are consistent with these conclusions. I start by briefly looking at the effect of benefits on the inflows into unemployment and then in section three at the effect on the duration of unemployment. The concluding section draws out the policy recommendations.

2. Unemployment Benefits and Inflows to Unemployment

The unemployment benefit system may increase the number of voluntary quits and hence the inflows into unemployment. These will comprise those who prefer a spell of unemployment to work and those who choose to search for new work while unemployed rather than while in employment. In either case the higher the ratio of unemployment benefits to after tax earnings while employed, termed the entry replacement ratio, the greater would the inflows be expected to be. It is also likely that the level of, and administration of, unemployment benefits may influence inflows to unemployment from outside of the labour force. For example, a generous benefit system may lead to young people entering unemployment rather than staying on at school.

The structure of the system might also influence inflows in that if there is an extended waiting period before benefit is paid, the incentive to quit voluntarily would be correspondingly reduced. Further, in many countries those who leave employment voluntarily are either disqualified from benefit or receive benefit after an extended waiting period. Formal research has, however, concentrated on the relation between entry replacement ratios and inflows to unemployment (from either of the two other labour market states) rather than on the effect of the administration of benefit procedures. This concentration has come about because in most instances it is very hard to derive summary measures of how generous, or otherwise, are the administrative rules.

Trivedi and Kapuscinski (1985) have estimated equations explaining inflows into unemployment in Australia for the period 1970-80. While this evidence is now a little dated the results are of interest as it was in this period that substantial increases in replacement ratios occurred in Australia. It shows that changes in the replacement ratio had only a weak effect on inflows, their effect being most noticeable in the case of adult males where the elasticity of inflows with respect to the replacement rate was of the order of 0.6. This is to be interpreted in the following way. If the replacement ratio was raised by ten per cent then this is estimated to lead to a six per cent increase in the rate at which people flow into unemployment. …

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