Unemployment Extension

2/16/2011

Over the next 5 months, millions of people will be losing their unemployment benefits. These benefits are different for each state but are based on guidelines from the Federal Government. Those who have used up all of their benefits, the “99ers,” are waiting on 2 bills to be passed in Congress to change the current Unemployment Extension Tier System.

They are called the “99ers” because they have been unemployed for up to 99 weeks and no longer receive benefits from the government.

The 99er-aiding Amendment would add another 14 weeks of unemployment benefits to the first tier of unemployment.  The second bill, the Americans Want to Work Act of 2010, would add an additional fifth tier to the employment system, thereby adding an additional 20 weeks of unemployment benefits.

The current Tier System is very confusing and differs according to each state, but the standard is 26 weeks of benefits from the State. The Federal Government also offers 4 tiers of emergency unemployment benefits which are extensions once the 26 weeks are all exhausted. A person can go from Tier 1 to Tier 4 which gives them up to 79 weeks of benefits while searching for a job—people are eligible for the third and fourth tier depending on how large their state unemployment is. These benefits come from our taxes.

Is this extension a good idea? Or are we prolonging the unemployment process, allowing people to take advantage of our assistance programs?

Nobel Prize winner, Paul Krugman, claims that those against the extension are "a coalition of the heartless, the clueless, and the confused."

He believes that an extension on unemployment benefits will have trouble being passed because people are misinformed about what these benefits do; they believe that there is a large disincentive to find a job—which is  untrue—and that increasing the budget deficit is a bad thing to do. Krugman believes that by spending money, increasing the budget deficit, we can turn around our “depressed” economy. By not doing so, we are being “cruel” to the unemployed.

He goes onto say:

What’s limiting employment now is lack of demand for the things workers produce. Their incentives to seek work are, for now, irrelevant...anyone who thinks that high unemployment in the first quarter of 2010 has anything to do with workers getting excessively generous benefits must not get out much.

And the truth is that unemployment benefits are a good, quick, administratively easy way to increase demand, which is what we really need. So right now they have the effect of reducing unemployment.

David Moberg uses data from the Congressional Budget Office and Labor Department that says that “for each dollar spent on unemployment benefits, the gross domestic product grows by roughly $1.90 to $2.00.” He also shows that the $65 billion increase in government spending will be offset by this increased consumption and really only will cost $26 Billion.

All of this these recommendations have roots to Keynesian economic theory. These people believe that government spending can affect overall aggregate demand of an economy and its output. They also believe that recessions are economic failures that the government should fix.

Basically Krugman and Moberg believe that these unemployment benefits encourage job growth and national productivity at a relatively low cost to the nation. But with these arguments, why are people still in opposition to these extensions? Let’s look at 3 reasons including some economic theory that can be used in opposition to extending these unemployment benefits. Maybe those in opposition of extending unemployment benefits aren’t as confused as Krugman claims.

First, according to the Real Business Cycle Theory, government intervention has only a small effect on the economy.

Government intervention that tries to increase GDP through consumer spending effects the economy less significantly; the level of consumption is actually determined by business productivity. In 2004 Finn Kydland and Edward Prescott received the Nobel Prize for demonstrating that changes in economic productivity affect GDP, consumption, and investment (either by consumers or the government)—not the other way around. This supports the Real Business Cycle Theory.

This would contradict Moberg’s claim of offset government spending through increased consumption.

Second is the concern of how to pay for these extended benefits. The typical alternatives are to increase taxes or cut spending from other areas. It seems likely that taxes would be chosen since Obama has already proposed large budget cuts that have angered many people. Even if taxes aren’t increased now, according to traditional debt financing, taxes will be increased for future generations to pay off this debt.

In response to Krugman and his increased spending, Josh Hardwick says that if taxes are increased, now or in the future, there is a disincentive for others to work and small businesses to grow. This causes a decrease in available jobs and an increase in unemployment.

This can be explained by looking at a labor supply and labor demand graph.

While there is a temporary increase in taxes, business owners have a reduced incentive to expand their business; they’re forced to shrink their demand for employees (labor supply) in order to pay the same amount in taxes as before.

At the same time a reduction in labor supply decreases workers’ wages. With a decrease in wages, workers are less likely to enter the workforce because their free time as risen in value in relation to the time they would spend at work (a decrease in labor demand). This is called the Substitution Effect.

Finally, there is evidence that unemployment benefits create a significantly large enough disincentive for people to actually take jobs.

Thomas F. Cooley and Peter Rupert refer to a recent Beveridge Curve from the Bureau of Labor Statistics. This graph shows the relationship between current unemployment and job creation. Over the past year unemployment has remained constant while the number of jobs created as risen. They claim that this is caused by an inefficient market system and that workers are becoming pickier.

Tarheel Red points to 2 important studies, both in Denmark and Pittsburgh.  Just as unemployment benefits were about to run out, the “return to work rate” miraculously spiked upwards. These studies suggest that people will do what is in their own best interest. When unemployment benefits give workers more value than a potential job, most workers will choose the benefits.

Plus, the longer someone is out of the workforce, the more their skill set declines. I would imagine that it is very unlikely for someone that has been out of the work force for a year (52 weeks) let alone 99 weeks, could perform as well in their respective profession as when they left their job. Keep in mind that those in school gaining new skills are not counted as unemployed.

To be honest, I can see why people are in opposition to this extension. There are widely held economic theories and behavioral studies that support it. That’s why the debate between Classical and Keynesian economists has gone on for decades.

And continuing to extend these benefits can’t be a self sustaining policy. By increasing unemployment benefits in order to increase GDP, we are basically paying ourselves through higher taxes. Eventually benefits will end and these people will have to accept the jobs that are already being created.

Taking all of this into consideration, I would still have to agree with Krugman and extending the unemployment benefits because this recession is nothing like we’ve ever seen before. Classical Economic Theory can’t explain everything that is going on in the economy and perhaps government intervention is the way to go. Just by doing nothing, unemployment is very high (no, the market is not self-correcting itself) and because those receiving unemployment benefits will be consuming everything they receive, it makes sense that consumption and output will increase.

Even if there is a chance it could be a wrong move, instead of doing nothing, I would rather help out those suffering from unemployment.

**Update 4/1/11: “The Federal extended unemployment benefits… will continue through 2011” with 99 weeks in states with high levels of unemployment. But, there is no fifth tier. The 99ers are receiving no more benefits.