With the economy weakening, some analysts have argued for
increasing unemployment insurance (UI) benefits from 26 weeks to 39
weeks to stimulate economic growth. Few studies support the idea
that extending unemployment benefits significantly stimulates the
economy. In addition, extending UI benefits would do the
- Encourage unemployed workers to stay out of work longer to
- Encourage employers to wait longer to rehire laid-off workers;
- Do relatively little to increase consumption.
To stimulate the economy and create jobs, Congress should
increase the incentives for businesses to invest.
No Economic Stimulus
The government provides unemployment benefits to workers who are
involuntarily laid off from work. These benefits replace a fraction
of the workers' weekly income, to a maximum set by state law, for
up to 26 weeks. Unemployment benefits can cushion the blow of job
loss and provide the unemployed with income support while they
search for a new job.
The Congressional Budget Office (CBO) recently issued a report
claiming that extending the length of time that workers can collect
UI benefits to 39 weeks would be one of the most effective stimulus
measures Congress could pass. The report argues that this
would transfer money to workers likely to immediately spend it,
boosting consumption. Notably absent from the CBO report was actual
research that supports this claim.
Economists in the 1960s thought that unemployment insurance
could function as an important, automatic economic stabilizer.
Research in the 1970s demonstrated that this was not the case, and
most studies since then have concluded that unemployment insurance
plays a relatively small role in stabilizing the economy.
State-level studies find that unemployment benefits provide
virtually no economic stimulus. The lack of evidence for this
connection is not surprising, because unemployment insurance is not
designed to stimulate the economy.
Extending UI Extends Unemployment
Unemployment insurance gives money to workers that they lose
once they find a job. This encourages workers to remain unemployed
to collect benefits. Even for conscientious workers, UI reduces the
pressure to seek employment. Unsurprisingly, research shows that
when the government increases the duration of UI benefits, the
length of time workers spend unemployed also increases.
Figure 1 comes from a study of unemployed workers collecting
benefits in Pennsylvania. It shows the probability that unemployed
workers in Pittsburgh will find work, either with a new employer or
with their old employer, as they exhaust their UI benefits.
Relatively few workers started work on any given week. However, a
full 28 percent of workers who had not yet found jobs found them as
soon as their UI benefits ran out--10 percent with their old
employer and 18 percent with a new employer. Unemployment insurance
encourages many workers to delay starting work while they collect
Many other researchers have come to the same conclusion.
Researchers at Harvard found that extending unemployment insurance
eligibility by 13 weeks increases by two weeks the amount of time
that workers remain unemployed. Each additional week that the
government extends UI benefits extends the length of time the
average worker stays unemployed by 0.16 to 0.20 weeks. Since
some workers find jobs in the first month of unemployment,
extending UI means significantly longer periods of unemployment for
those who do not start work quickly.
Some analysts argue that greater benefits have less of a
disincentive effect during times of high unemployment. The
facts refute this argument: Labor market conditions have little
effect on how workers respond to additional UI benefits.
Employers Wait Longer to Rehire
Extended UI not only encourages workers to take longer to start
working again but also encourages companies to wait longer before
rehiring workers they have laid off. Employers take into account
the fact that their laid-off workers will receive UI and are slower
to hire them back. Figure 1 shows that fully 10 percent of
unemployed workers who exhausted their UI benefits in Pittsburgh
were hired the next week by their previous employer.
It is extremely unlikely that employers did this because of a
sudden jump in business the week benefits ran out. Instead,
employers appear to use UI to hold their workforce together without
paying their workers during times of low demand. This hurts the
well-being of workers and their families and leaves them without
important health benefits. Extending UI benefits an additional 13
weeks would allow employers to keep their workers "on call" without
paying them for a longer period.
Extended unemployment insurance lengthens unemployment. It
encourages workers to stay unemployed and companies to delay
rehiring laid-off workers. Higher unemployment and fewer workers do
not promote economic growth.
Modest Increases in Consumption
The theory behind the UI-stimulus proposal holds that the
government should transfer money to workers who will immediately
spend it, because greater spending increases aggregate demand and
stimulates the economy. This is a recycled version of Keynesian
economic theories that economists and policymakers rejected after
they failed during the 1970s.
These discredited theories stated that, in economic downturns,
investment stops responding to the interest rate, and any money
that is saved is essentially taken out of the economy, caught in a
"liquidity trap." Thus, the only way to boost the economy is to
increase consumption. However, little evidence suggests that
liquidity traps exist in the real world outside of economic theory.
Milton Friedman also demonstrated that workers do not consume a
fixed percentage of any income they receive. Rather, they base
their consumption decisions on their expected permanent income.
Thus, temporary increases in income that result from government
transfers have only modest effects on consumption.
Even if policymakers believe that increasing consumption is the
best way to stimulate the economy, research shows that extending
unemployment benefits is not the way to do it. Workers respond to
the incentives the UI system creates and do not spend every
additional dollar of UI benefits. The spouses of unemployed workers
with UI benefits work substantially shorter hours than those with
benefits. For married men, each dollar of benefits reduces their
wives' earnings by between 36 and 73 cents. Workers on UI
also spend less of their savings than those without benefits.
For many families, extended UI benefits would do less to increase
consumption than to provide alternative financing for consumption
that would nonetheless take place. Research shows that each
additional dollar spent on UI increases total consumption by
roughly fifty cents.
Furthermore, this research finding--that only 50 cents of each
dollar is spent--does not account for another way that UI reduces
consumption. Since UI increases the amount of time workers stay
unemployed, it increases the amount of time they go without earning
full wages or employee benefits. This artificially extended
unemployment further reduces the effect that additional UI benefits
have on increasing consumption.
Congress understandably wants to prevent the economy from
slipping into a recession. However, Congress should ensure that its
actions are effective. Extending unemployment benefits creates
incentives for workers to remain unemployed and for employers to
wait longer to rehire their workers. Both of these consequences
harm the economy. Arguments that UI stimulates the economy rely
solely on the theoretical benefit of transferring money to people
who will quickly spend it. Actual studies conclude that
unemployment insurance provides little economic stimulus. Even if
Congress wants to boost consumption, studies show that workers
spend just 50 cents out of every dollar in additional UI
Congress should not extend unemployment insurance benefits to 39
weeks. Congress should instead increase incentives for businesses
to invest in the economy, such as through accelerated depreciation.
This will stimulate economic growth while making it easier for
unemployed workers to find jobs.
James Sherk is Bradley
Fellow in Labor Policy, and Patrick Tyrrell is a Research
Assistant, in the Center for Data Analysis at The Heritage