Neil H. Buchanan

The Debate Over Unemployment Benefits: Economics is Complicated, Heartlessness is Simple

By NEIL H. BUCHANAN
Thursday, July 1, 2010

The United States Senate recently failed to extend unemployment benefits for 1.2 million people who have been out of work for well over a year, with all forty-one Republicans and Ben Nelson, Democrat of Nebraska, joining in a filibuster to prevent a vote on the measure. This decision may or may not turn out to be smart politics, but we can be certain that it is both economically foolhardy and gratuitously cruel.

Measured unemployment is currently hovering just under 10%, with 15 million people unsuccessfully looking for work, on top of millions more who have understandably given up looking for jobs in the face of a depressed economy, and still more who are involuntarily working part time because they cannot find full-time jobs. The job market is so forbidding that there are five or six unemployed workers for every available job in the country. That ugly national picture is even worse in some regions, with unemployment in states like California and Michigan, and many others, well in excess of 10%.

It seems highly unlikely that the opponents of extending unemployment benefits were relying on economic arguments to decide how they would vote on the measure. The parties are in full-scale campaign mode, with the mid-term elections now barely four months away. Even so, for purposes of public relations, some politicians and their supporters in the punditocracy have offered a few arguments against extending benefits that at least have the gloss of economic reasoning. That reasoning, however, fails to hold up to serious inspection.

In this column, I will describe two arguments that have recently been offered to oppose extending long-term unemployment benefits. I will show that the reliability of those arguments is entirely contingent on economic conditions that simply do not exist, and that will not exist for years to come. Marshaling plausible economic arguments to support crass political decisions, it turns out, is not as easy as it seems.

Work Disincentives and the Timeless Debate About Unemployment Benefits

When a person loses his job because he has failed to perform adequately, or because he has undermined workplace morale, or for any reason that amounts to "good cause," few people feel much sympathy. The economy dispenses rewards and punishments, and a person needs to understand that actions have consequences. Even in such a case, of course, the loss of a job can inflict pain on innocents, such as the worker's children. Similarly, his neighbors' home values might decline when the worker stops taking care of his property; and if the fired worker ends up becoming desperate enough to commit crimes, his victims will become collateral damage of the lost job. Still, there is a shared sense that some jobs are lost for understandable reasons, leaving little sympathy for the laid-off worker.

When a person loses his job due to his company's decision to downsize, however, the sense of blame goes away. The worker did nothing wrong, but his employer might have simply decided that it is no longer competitive in the line of business in which it is currently employing hundreds or thousands of workers.

Here, even though the workers are viewed as blameless, the economic climate matters. If the layoffs occur in an economy that is otherwise rather healthy, then the workers should be able to find other jobs with a bit of effort in reasonably short order. Hence, workers often receive what is sometimes referred to as "transition assistance," that is, money allowing them to weather the transition to the new job. But that transition money will only last for a limited time.

The very reasonable policy concern that militates against providing further assistance in these circumstances is that job seekers who are being paid even while they do not work will become complacent and stop looking for work. In that case, the attempt to use public policy to ease the transition between jobs can become cancerous, inducing workers to settle for a life of non-work. At least, in theory.

Do Unemployment Benefits Really Discourage People From Working?

There are two important factors that determine whether payments to unemployed workers will truly create long-term idleness, as some claim. The first is the relative generosity or miserliness of the benefits. If the government pays a person a paltry $1 per year while they are unemployed, then of course, no one will view this as such a "sweet deal" that they will never work again. On the other hand, a payment of $1 million per year might induce even the most industrious among us to stop working.

The question, therefore, is how high benefits can be, before they induce workers to remain idle. Some evidence has suggested that the wealthier European economies erred in the latter half of the Twentieth Century by being too generous in their unemployment benefits. The United States, however, has never provided levels of support that allow unemployed workers to maintain a decent lifestyle. Thus, American workers simply do not remain unemployed as a result of receiving government support that is a comfortable alternative to working.

The second important factor that determines the economic impact of unemployment benefits is their duration. Even if the government were to err by giving workers benefits that would be sufficient to support their lifestyles, those benefits can simply be allowed to expire, after a certain time, without renewal. Knowing that their benefits have an end date should encourage recipients to become workers again.

Again, however, the United States has never been a country that has provided long-term unemployment benefits as a matter of course; rather, those who receive benefits have always been able to see before them a time, in the very near future, when those benefits would end.

The situation in this country, therefore, is rather stark: We provide stingy unemployment benefits, and we cut them off quickly. Whatever else one might say about that policy, its supposed incentives only work if the economy is healthy enough to provide work to job seekers.

The Great Recession and Unemployment Benefits: Extraordinary Measures for Extraordinary Times

When there is a significant downturn in the economy, the idea that an unemployed worker has brought his situation upon himself -- as well as they idea that the person must simply be given enough incentive to stop relying on "the dole" and find work -- becomes absurd. The entire economy is in a nosedive, and there are no jobs to be found.

Long-term unemployment in the United States is now at historically high levels, and in many areas, for many people, there simply is no work to be found. In this situation, it would seem insane to suggest that the economic arguments that would have been relevant to a healthy economy are still operative. Yet there are still those who make that argument.

Earlier this year, Senator Jon Kyl of Arizona argued that continued unemployment benefits are a disincentive to find work. Calling him out on this, the economist Paul Krugman described Kyl's argument as "bizarre." In response, the Senator wrote that even Krugman's own textbook admits that receiving unemployment benefits "reduces a worker's incentive to quickly find a new job."

Mr. Kyl apparently believed that he had scored a major debating point, suggesting that Krugman was merely engaged in a "partisan attack" that ignored his own professional writing. What the exchange really demonstrated, however, is that economists are sensitive to context. If the economy is wracked by high unemployment, there is precious little reason to worry that workers are turning down jobs simply because they want to keep the unemployment-benefits gravy train rolling.

The U.S. economy is in its worst shape since the Great Depression. Suggesting that unless workers lose their scanty unemployment benefits, they will not go out and find a job is both bizarre and inhuman. Unfortunately, that is not the only misapplied economic argument in this debate.

An Often-Underestimated Advantage of Granting Unemployment Benefits: Workers Will Spend and Support the Economy

Beyond the familiar argument over whether unemployment benefits create disincentives to work, another essential question is whether providing those benefits will help to turn the economy around. The major problem right now in the United States economy is that businesses cannot sell their goods, which means that they have no reason to hire any of the millions of willing, unemployed Americans who are suffering in this economy. The less money we spend, the worse matters become. And the worse matters become, the less we may spend.

When the government tries to stimulate spending, in an attempt to "prime the pump" and inspire businesses to set in motion a virtuous (as opposed to vicious) cycle of hiring, it is important to know how long the process will take before it shows results. Last year's debate about the so-called stimulus package, for example, included concerns that government spending projects were not "shovel-ready," meaning that the money would not be spent soon enough to help the economy. What was needed, we were told, was spending that would boost the economy right away.

It is difficult to imagine a more perfect solution to this problem than unemployment benefits. Laid-off workers -- especially the long-term unemployed who have long since used up any savings, and are even selling their property to survive -- desperately need money. As soon as the check comes in, the money will be spent. The businesses at which the money is spent will thus be encouraged to hire more workers, or at least not to lay off more workers.

Or so one would think. In what at least qualifies as a novel error, the pundit George F. Will offered the opinion, on one of this past Sunday's morning chat shows, that unemployment benefits are not stimulative at all. Such benefits, he explained, are not "permanent" income; and only permanent income causes people to spend money.

This is truly a weird claim, but the source of the error is not as obvious as it might seem. Will was apparently referring to the "Permanent Income Hypothesis," an economic theory that says that people make lifetime consumption decisions not on the basis of transitory shifts in income, but on the basis of expected lifetime earnings. According to the theory, a worker who receives a one-time $10,000 bonus might realize that the bonus is a fluke, thus inducing her to save the money for the future, rather than spending it. A worker who receives a permanent $10,000 per year raise, by contrast, might permanently change her spending.

Of course, this is merely a theory, and one that hardly provides a universally-applicable description of human psychology or behavior. While some people might look at a one-shot bonus as a good opportunity to add to their retirement account, it is certainly easy to imagine many more people viewing the bonus as a reason to have a party, or to buy a Rolex, or whatever. It is, again, an empirical question whether the net effect on spending will be positive or zero. The best evidence supporting the permanent-income hypothesis, moreover, comes from the 1960's, when the economy was extremely strong and unemployment was quite low.

Why the "Permanent Income" Argument Is Totally Misplaced and Invalid in the Context of Unemployment Benefits

The argument about permanent income, in other words, suggests that people will view unemployment benefits as merely transitory, thus causing them to ignore the money and put it in the bank unspent, relying on their other sources of money to buy food and pay the rent. This argument might apply to certain tax cuts -- especially tax cuts for those who are not living on the edge of destitution. But it cannot possibly apply to an extension of unemployment benefits for the long-term unemployed, who urgently need the money they receive to cover household necessities such as rent, groceries, gas, children's needs, and the like. A luxury like savings is simply not available to those who have found their past salary replaced by the scanty benefits Americans who lose their jobs receive.

In short, the argument over unemployment benefits is, at the same time, both complicated and simple. It is complicated if one wants to think about the perfect way to deal with unemployment in an economy where people have ample safety nets and where good jobs are just a few weeks away.

In the world in which we currently live, however, there is no such complexity. The millions of unemployed Americans do not need further incentives to look for jobs. The economy needs spending to prevent even greater damage to the country. Cutting off unemployed workers now is both foolish and inhuman. And providing continuing benefits shouldn't even be a difficult policy choice; it should be a no-brainer, something on which we all can easily agree.


Neil H. Buchanan, J.D. Ph. D. (economics), is a Visiting Scholar at Cornell Law School, an Associate Professor at The George Washington University Law School, and a former economics professor.

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