Is Higher Unemployment the Hidden Cost of Extended Unemployment Benefits?

The Cheat Sheet

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Source: Bytemarks / Flickr

Source: Bytemarks / Flickr

In December, the headline unemployment rate fell to 6.7 percent, its lowest level since the crisis. At 10.3 million, the total number of unemployed persons in the United States also hit a post-crisis low, down 15.6 percent from December 2012. Even U-6 unemployment, a measure that includes marginally attached workers such as those working part-time for economic reasons, has been on the decline, although at 13.1 percent the rate is still elevated.

This is all well and good, but there’s more to the picture than optimists may suggest. Just 74,000 payrolls were added in December, according to the Bureau of Labor Statistics, a miserably low figure and well below the 200,000 expected by economists. Meanwhile, the labor force participation rate declined by 0.2 percentage points to 62.8 percent, well below pre-crisis levels of about 66 percent. The number of unemployed people declined by 490,000 people, but few of them were actually put on payrolls.

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Perhaps most troubling, though, is that the average duration of unemployment remains enormously high at 37.1 weeks, about twice what it was before the financial crisis. The percentage of the total unemployed who have been without work for 27 weeks or more, placing them under the umbrella of the long-term unemployed, is 37.6 percent, or nearly 3.9 million Americans.

In order to help combat this problem — which, believe it or not, peaked in severity two years after the recession technically ended in 2011 and only really began to moderate in 2013 — the federal government extended emergency unemployment insurance benefits. The benefits were extended to the long-term unemployed by the federal government through the Emergency Unemployment Compensation program, which was enacted in June 2008. The program increased the number of weeks for which an unemployed person could claim benefits, from around 26 to as much as 73.

Unemployment insurance programs are mandated by the federal government but are mostly run and paid for by the states, and those governments have some flexibility in setting requirements and payouts for the insurance. The costs for a supplemental, permanent program called Extended Benefits that can add between 13 and 20 weeks of insurance — depending on the state-level situation — are split between the state and the federal governments.

The EUC program was fully funded by the federal government and provides additional insurance on top of the normal and Extended Benefits insurance programs. The extended program impacts about 1.37 million Americans.

But emergency programs aren’t free and they can’t last forever. The supplemental EUC program is on the chopping block, and liberal and conservative factions across the country are playing tug-of-war with the implications of ending extended benefits. Generally speaking, liberal Democrats want to extend federal funding for the benefits to the tune of about $25 billion, while conservatives don’t believe extending the program is worth the cost.

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Specifically, one of the arguments coming from the conservative camp is that extended unemployment insurance benefits can actually have an adverse effect on the labor market. The labor market, like all other markets, is governed by supply and demand: workers must be willing and able to supply their labor, and employers must demand it. At some price point in the middle, employment occurs.

But unemployment insurance can act as a sort of price floor for labor. If a worker is receiving benefits, that worker would be unlikely to accept a job that paid less. Beyond that, argues a paper titled “Unemployment Benefits and Unemployment in the Great Recession: The Role of Macro Effects” — written by Marcus Hagedorn, Fatih Karahan, Iourii Manovskii, and Kurt Mitman, and published by the National Bureau of Economic Research — unemployment insurance actually puts upward pressure on the price of labor. Many workers don’t just want to earn more than they are receiving in benefits, they want to earn meaningfully more. Labor and the job search are not necessarily substitutes, after all.

The paper argues that this upward pressure on labor prices ultimately reduces demand for labor. Employers, many of whom are also still reeling from the financial crisis, will have less demand for labor the more expensive it gets. If employers have less demand for labor, they will naturally hire fewer people, meaning that the unemployment rate will remain elevated.

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The paper calculates that this effect can have a significant impact on the overall level of unemployment. The authors state that, “During the Great Recession, unemployment benefits have been on average at 82.5 weeks for approximately 16 quarters. Translating this to rates, we would predict a rise in unemployment from 5 percent to 8.6 percent.” If true, this is a phenomenon that occurs from both the supply side (workers unwilling to work for less) and the demand side (employers unwilling to pay higher prices for labor). As argued in the paper, “Extending unemployment benefits exerts an upward pressure on the equilibrium wage.”

To what degree this effect actually manifests in the real economy is unclear. What we can observe, though, is that there has been relatively weak upward pressure on wages and the cost of labor.

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