Employment Guide: Helgerman: Extension of unemployment benefits beneficial to economy

In his recent State of the Union address, President Barack Obama challenged Congress to restore the unemployment benefits that had expired at the end of last year. And, as it is wont to do, Congress failed to take action.

During periods of economic calm, the Unemployment Compensation program, run at the federal and state levels, delivers payments to citizens out of work for a maximum of 26 weeks (the actual number varies by state). As it has done during many recessions in the past, Congress provided extended unemployment benefits in 2008 by passing the extended Emergency Unemployment Compensation program into law.

However, this legislation expired Dec. 28 of last year, and 1.7 million people who would have been covered under the extended program are currently without insurance. Despite the president’s repeated urging, the Senate failed to extend insurance in the middle of January and recently failed to do so once more.

Unfortunately, the decision to not extend unemployment benefits at this juncture is a mistake. Not only will there be tangible economic benefits upon passage, but many of the adverse impacts cited by opponents of the legislation will fail to materialize. 

Since this is an issue of employment, let’s look at the economics of extending unemployment insurance. 

First, extending benefits will have direct impacts on the government’s fiscal position and the economy. Clearly, as providing benefits requires spending money, an extension will worsen the government deficit. However, the impact will be minimal (an estimated $6.5 billion) on a deficit that is shrinking rapidly. 

Additionally, unlike most other government programs designed to act as a stimulus, unemployment insurance has a large economic impact, as money is doled out to people who will most likely spend it. This stands in contrast to tax decreases, which are more likely to be saved, especially during times of economic duress. The resultant GDP growth will increase tax revenues, further mitigating the fiscal impact.

And even if there is an adverse impact on the budget, it will be in the form of a very welcome economic stimulus. With interest rates near zero and multiple rounds of quantitative easing having lowered long-term bond yields, it is clear that the Federal Reserve has very few monetary policy tools left to lower the unemployment rate, which is still stuck at 7 percent.

Second, extending benefits will have indirect impacts on employment. Essentially, by lengthening the duration of unemployment benefits, it is argued (mostly from the right) that the government incentivizes workers to work less diligently to find a new job, increasing the unemployment rate. While correct at a basic level, this reasoning does not take into account the complexities of a modern labor market.

In a note posted online by Michael Feroli, chief U.S. economist at JPMorgan Chase, Feroli distinguishes two ways in which restricting unemployment compensation could lower the unemployment rate: an employment effect, in which people are incentivized to take jobs they wouldn’t with longer compensation, and a participation effect, in which people give up the search for a job and drop out of the labor force entirely.

A lot of attention has been focused on North Carolina, which cut its extended unemployment benefits in July. Pundits and politicians on the right point to the fact that after benefits were cut, the unemployment rate fell by 1.5 percent in the state, compared to 0.4 percent nationally. However, as The Economist notes, a large drop in the labor force suggests that this was mostly due to the participation effect, a conclusion to which Feroli also came.

Clearly, if refusing to extend unemployment benefits leads to a fall in the unemployment rate only through a shrinking workforce, this fall is not desirable. Keep in mind that there are various ways to report the unemployment rate and that the one traditionally cited doesn’t treat workers who have given up the search for work (discouraged workers) as unemployed. Wider measures estimate unemployment at upwards of 13.1 percent, a number that would likely rise, not fall, if unemployment benefits are not extended.

Finally, any analysis of unemployment insurance must consider the benefits of search externalities. Essentially, as workers decrease their efforts to look for a job, it becomes more likely that any individual worker will be able to find a job. Research suggests that unemployment insurance should be more generous during recessions due to the increased presence of this positive externality. 

Additionally, the recent opening of two new Wal-Marts in the capital provides evidence that these externalities are highly present now.

So especially with midterm elections due in November, perhaps Republican members of Congress should consider their chances of re-election before voting against an Emergency Unemployment Compensation extension. 

Write to Thomas at teh18@pitt.edu.