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Unemployment extension may actually hurt long-term unemployed

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Democrats and Republicans are currently locked in a battle over how to pay for a reauthorization of the extension for long term unemployment benefits. For the most part, the debate is only over how the extension of unemployment benefits should be paid. As PBS reported, most Republicans don’t oppose the unemployment extension, but favor offsetting the increased spending with cuts in other budget areas. Little, if any, attention has been given to whether the unemployment benefits should be extended at all however. The Senate passed its version of the plan on January 7, but the bill faces an uncertain future in the House. Politically the extension is popular, but many economists are not sold on the benefits of the extension.

According to the Center for Budget and Policy Priorities, unemployment insurance typically lasts for 26 weeks. The Emergency Unemployment Compensation program extended benefits for an additional 14 to 47 weeks. The number of additional weeks varied by state and was based on state unemployment rates.

In December 2013, New York Times columnist Paul Krugman attacked the idea that extending unemployment payments may be harmful to the unemployed. Krugman claims that much of the research on the effects of unemployment insurance is decades old and that ending unemployment insurance would not create more jobs. In Krugman’s view, the economy is limited by demand, not supply, “and slashing unemployment benefits — which would have the side effect of reducing incomes and hence consumer spending — would just make the situation worse.”

There are some problems with Krugman’s analysis. As Krugman himself notes, unemployment insurance typically pays between 40 and 50 percent of the worker’s previous pay. This hardly seems enough to stimulate significant demand. In fact, such benefits are more accurately described as subsistence payments that merely help the unemployed to survive. About.com compiled a list of maximum unemployment benefits by state. The highest was Massachusetts at $653 per week. The lowest was Mississippi at $235. Georgia’s maximum weekly benefit is $330.

Krugman may also be off base about the number of available jobs. In October 2013, the National Federation of Independent Businesses reported that 20 percent of business owners had job openings that they could not fill. This begs the question of why business owners cannot fill jobs in an economy with unemployment rate that has been chronically above seven percent for the past five years. In reality, the employment situation is even worse than reflected in the unemployment rate. As previously reported by Examiner, the civilian labor force participation rate has continued to fall even as the unemployment rate declined. This indicates that much of the decline in the unemployment rate is due to people leaving the work force.

In contrast to Krugman’s claim that more demand is needed to stimulate the economy, the NFIB survey found that poor sales ranked third when business owners were asked what the most important problem facing small business. Government requirements and red tape was the selected as the worst problem. Taxes was rated a close second.

Part of the answer to the business staffing problem probably lies in the number of long-term unemployed. According to the November 2013 employment report from the Bureau of Labor Statistics, the most recent available, more than 53 percent of the unemployed have been out of work for more than 15 weeks (almost four months). Thirty-seven percent have been out of work for more than 27 weeks (almost eight months).

A January 8, 2014 report in CNN Money cited a report by the Council of Economic Advisors that found that workers who had been unemployed for less than five weeks had a 31 percent chance of finding a new job or returning to their old one. At 27 weeks, the odds of becoming employed again drop to 12 percent. For those who have been unemployed for more than a year, the chances of finding a job are only nine percent. In the current economy, it takes about four weeks for most workers to either find a new job or give up their search.

When workers are unemployed for more than a year, it becomes very difficult to find a job. A worker’s skills deteriorate, professional licenses and certifications may lapse, and prospective employers begin to question their work ethic, health, or otherwise try to determine why they haven’t worked in so long. After more than a year of unemployment, many workers move from being unemployed to being unemployable.

It might seem counterintuitive that the unemployed would reject a job to maintain a meager unemployment payment, but Pete, a union electrician, explained the thinking in a piece he wrote for an About.com series of stories of the unemployed. Pete writes, “I'm used to bringing home $1,500 gross a week and now with unemployment I bring home $425 a week…. I keep looking for work outside of my trade, but all there is are 10 dollar an hour job[s] or less or part time. Now why would I get a $10 an hour job working 40 hours a week without insurance and benefits when I make that being unemployed?”

In 2010, the Wall Street Journal quoted an economics textbook written by Lawrence Summers, at the time President Obama’s chief economic advisor. In 1999, Summers had written, The second way government assistance programs contribute to long-term unemployment is by providing an incentive, and the means, not to work. Each unemployed person has a 'reservation wage'—the minimum wage he or she insists on getting before accepting a job. Unemployment insurance and other social assistance programs increase [the] reservation wage, causing an unemployed person to remain unemployed longer.” Pete’s $425 weekly unemployment payment has obviously increased his reservation wage above $10 per hour.

Other government benefits that workers might receive in addition to unemployment payments also drive up the reservation wage. Last September, Examiner reported on a Cato Institute study that found that welfare payments in 12 states were worth more than a minimum wage job. The Affordable Care Act’s Medicaid expansion extends government health insurance to the poor in states that chose to enact the expansion. Other types of government assistance include food stamps and disability payments, both of which reached record highs in 2013.

In contrast to Krugman’s claim that studies critical of the Obama Administration’s claims about the stimulative characteristics of unemployment payments are “decades old,” the New York Fed published a detailed paper on the subject in October 2013. This study looked at bordering counties in different states and used data from the Great Recession’s high levels of unemployment and the Obama extension of emergency unemployment payments. Since the adjoining cross-border counties were part of the same labor market, a major difference in unemployment rates was traced to state unemployment insurance laws.

The study’s authors found that “having access to longer spells of benefits improves the outside option of workers and leads to an increase in the equilibrium wage. This lowers the accounting profits of firms and reduces vacancy posting to restore the equilibrium relationship between the cost of firm entry and the expected profits.” In layman’s terms, extending unemployment benefits for longer periods causes wages to rise, which in turn causes fewer new jobs to be created.

The study shows that “unemployment benefit extensions can account for most of the persistently high unemployment after the Great Recession.” The data showed that “border counties with longer benefit durations have much higher unemployment, despite the potential benefits of spending” money received from unemployment payments. The negative effects of higher unemployment outweighed any increase in demand.

In the end, extending unemployment payments allows workers like Pete to maintain a high reservation wage which keeps them unemployed longer, possibly to the point that they are no longer employable. If Pete took a lower paying job than his old one, he might lose money initially, but he would begin rebuilding his resume with recent job experience. He could use a low-paying entry level job to restart his career and work his back up the career ladder. By staying on unemployment, Pete goes nowhere. He is trapped at $425 per week.

Several years ago I was laid off when my company lost its main customer. I was unemployed for five weeks before I started work with another company. My pay at the new company was significantly less than I had been receiving in unemployment compensation, especially after insurance costs were deducted. For a time, I worked a second job to supplement my primary paycheck. Even then, we had to use credit cards to make ends meet. Before too long, however, I received a pay raise. Things got even better when my experience led to another job offer with even better pay.

While not everyone who is unemployed chooses to keep receiving benefits over taking a lower paying job, the expiration of unemployment benefits may well have the effect of lowering the reservation wage for many of the long-term unemployed. This would be an incentive for people like Pete to restart their lives and careers.

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