Losing unemployment benefits may help in the long run, but will hurt in the short run

December 18, 2013
Long-term unemployment rate remains high even with economic recovery (Washington Post)
Long-term unemployment rate remains high even with economic recovery (The Washington Post)

As of November, some 4 million American adults hadn’t worked in more than six months. To help tide them over during the economic downturn, each of them has been receiving a payment of about $300 a week, thanks in part  to a federal emergency unemployment compensation program that President George W. Bush signed into law in June 2008.

Those benefits are now coming to an abrupt end. Last week, the House of Representatives voted 332 to 94 for a budget deal that ends this program. The Senate is expected to approve this deal.

What this deal means is that some 1.3 million people will no longer receive unemployment benefits as of the end of December and, if Congress doesn’t authorize extended benefits again, more than 2.5 million people may lose their benefits by the end of 2014. (Sen. Kirsten Gillibrand (D-N.Y.) opposes the cut in long-term unemployment benefits. Senate majority leader Harry Read (D-Nev.) is expected to try to extend benefits for one year early in 2014, while Senate Democrats may work to retroactively extend benefits when the Senate returns Jan. 6, 2014.)

The long-term unemployment situation doesn’t seem to merit this cut. While the overall unemployment rate has fallen, the long-term unemployment rate has remained stubbornly high at about 35 to 40 percent of the total unemployed. The typical unemployed worker has been seeking a job for more than 37 weeks.

Economists have puzzled over this conundrum and tried to figure out ways to reduce that high rate. Sustained economic growth is one way to eliminate long-term joblessness.

That’s pretty basic. Economic growth creates the demand for jobs that will lead companies to hire workers. They generally begin with those who have been out of work the shortest amount of time and then progress through to those who have been out of work the longest.

The U.S. economy showed a remarkable burst of growth in the last quarter, rising by  an annual rate of 3.6 percent. That growth marks the ninth straight quarter of real economic growth and represents a significant improvement from the 6.3 percent economic decline in the depths of the recession in the last quarter of 2008.

Economic growth is good for workers since, as a rule of thumb, every 2 percentage points of economic growth leads to a reduction of 1 percentage point in the unemployment rate. The unemployment rate has, in fact, fallen sharply from its peak of 10 percent in October 2009 to 7 percent in November of this year.

Nevertheless, long-term unemployment is a real problem in this economy. Compared with previous recoveries, when long-term unemployment has made up about 20 percent or less of the total unemployment, long-term unemployment now accounts for about 40 percent of adult unemployment, a rate that has been basically flat for four years.

The problem isn’t that these people aren’t looking for work. Nearly one in three adults without a job has spent more than a year looking for a job, according to the National Women’s Law Center.

One of the most contentious arguments among labor economists may be whether unemployment benefits actually increase unemployment (the other contentious argument is whether increasing the minimum wage also increases unemployment).

Not surprisingly, it’s hard to figure out whether extending unemployment benefits also increases unemployment. At first glance, some might say that if people are “paid to be unemployed” then people are going to be unemployed. That’s a rather simplistic argument, since it confounds the economic principle that wages are payments that labor receives for working, with the policy that unemployment benefits are payments that labor receives when there is insufficient demand to hire all the workers who seek a job. There’s nothing in economic theory that says that unemployment benefits are the “wages” paid to be unemployed.

That said, labor economists are interested in investigating whether extended unemployment benefits actually increase the length of unemployment. Here, things get a bit murkier. Recent research from Henry Farber of Princeton University and Robert Valletta of the San Francisco Fed shows that paying extended unemployment benefits slightly increases the unemployment rate. The unemployment rate was about 0.4 percentage points higher in 2010 — it was 9.0 percent instead of 8.6 percent — than it would have been without the benefits, according to their estimates.

More worrisome, the authors find that paying unemployment benefits for an extended time has a particularly bad effect on long-term unemployment. Long-term unemployment benefits may have caused the long-term unemployment rate to be one-quarter higher than it would have been without the benefits. In other words, up to one million people were out of work for more than six months because they were receiving benefits.

Of course, the Great Recession of 2009-2012 was much worse than the typical economic recession, with GDP falling sharply and the unemployment rate rising significantly. What these figures mean is that economic demand is much weaker now than is typical, meaning that workers have a harder time finding work now than in other, more “normal” recessions.

Despite the extension of long-term unemployment benefits last December, the number of those who haven’t had a job in more than six months fell by 718,000 in the past 12 months. Some of the long-term unemployed are finding jobs. That’s clearly good news.

What’s not clear, however, is how much long-term unemployment might have fallen if benefits hadn’t been extended. In other words, do American workers need to go through shot-term pain of losing unemployment compensation to benefit from the long-term gains of getting a job? That’s the experiment that the U.S. will test now that Congress has decided to stop paying extended unemployment compensation.

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Celia Cussen | December 18, 2013