Monday, December 3, 2012

Extending Unemployment Benefits Is Not a Solution

The "fiscal cliff" talks are bringing a series of policy issues into play, one of them being the extension of unemployment benefits. If Congress decides to not renew unemployment benefits, it is reported that it will impact over two million citizens. The Congressional Budget Office (CBO) recently published a report on unemployment benefits and how it would affect the economy if the benefits were extended either partially or in their entirety. The idea behind unemployment benefits is that they are supposed to temporarily help those who lost their jobs [in the recession] insure their savings and assets until they can get back on their feet and land another job. Although I am sure some people can think of me as callous for not wanting to extend these benefits because they are trying to peddle an argumentum ad misericordiam, there are a few reasons, mainly surrounded around the concepts of costs and effectiveness, that shape the foundation of my opposition.

One of the primary ideas behind unemployment benefits is that without them, it would reduce the GDP because the would-be beneficiaries would consume less. The idea, which is unsurprisingly Keynesian in nature, is the conclusion that CBO report arrives at. As long as consumption (aka aggregate demand) is boosted, then the problem is solved. But is it really? How can spending be the issue when the marginal propensity to spend was 0.98 pre-recession and only decreased to 0.94? If saving rates were high, I could at least amuse the thought, but since Americans love to spend, I cannot buy it. It's no wonder that government programs such as unemployment insurance disincentivize saving. Also, the idea of aggregate demand is one of indiscriminate spending. Not all spending, consumption, and production are created equal. Even the IMF recognizes the real possibility, and in many instances, the reality, of multiplier effects less than 1 (i.e., government spending is less effective).

If the program is so wonderful because the CBO estimates that it will create $1.10 for every dollar of input, why not extend unemployment benefits to everyone, or at least expand the program greatly? Because the CBO is only looking at half of the equation. My favorite reason for why the Keynesian thinking is flawed is the very idea behind a subsidy. As the adage goes, "If you want more of something, subsidize it; if you want less of something, tax it." What are we subsidizing? Unemployment, which means we get more of it....more on that in a moment. Second, you are taxing employers. Money does not grow from trees. Government does not have its own revenue base, hence the reason for taxation, which in this case is in the form of the payroll tax. When the government takes that money from the private sector, it dampens the private sector and causes a firm to produce less.

Although I would much prefer private donors, charities, and organizations to help with those who are temporarily unemployed, even if I were to concede to some temporary mechanism for unemployment benefits to be given by the government, they would need to be temporary. The fact that this a repeat of last year's discussion is ridiculous. Why? When you extend the benefits and make them more generous, like Congress is discussing, you decrease the incentive for an individual to look for work, which leads to structural unemployment. If you're disinclined to believe the conservative think-tank Heritage Foundation, maybe you'll take the word of Left-leaning economist Paul Krugman. After all, he was the one who gave this very explanation in his macroeconomics textbook (p. 210).

The reason why this disincentive exists is because individuals have a "reservation wage," which is the minimum wage an individual expects before accepting a job. The unemployment benefits cause the reservation wage to increase, which forces the individual to be pickier about job selection. This is not only the thinking in the CBO report (p. 9), but this also comes from Lawrence Summers, who was the former director of Obama's National Economic Council. Furthermore, the Federal Reserve Bank can hardly be considered a bastion for free-market thought, but amazing how they came to the conclusion that extended unemployment benefits actually increase unemployment (also see Katz and Meyer, 1990).

There is also the issue that over ten percent of unemployment benefits were paid in error. Once again, this brings up the issue of the effects of limited competition on efficiency. If a private firm misappropriated this large percentage of their produced goods, they would either adjust for the inefficiency or they would soon go out of business. When the government misappropriates the funds, they can still survive amidst the inefficiencies, which is unfortunate if the goal is to help people out, but over $5B has been misapplied. If that tax revenue were not collected via the payroll tax, employers could have used that extra money to create more jobs. Is it fair for working citizens to pay for a system that is ripe with abuse and fraud?

Unemployment insurance is more of the same "tax and spend" mentality that Washington has in mind. It does nothing to mitigate the wage rigidities, the misallocation of funds, or the fact that it de facto subsidizes unemployment. Interest rates are at extreme lows and consumption is still high, so to continue with this view that businesses cannot borrow or there are not any consumers out there to consume goods is false. Policy should be focused on incentivizing businesses to create more jobs and providing businesses with better confidence in the markets to hire. In broad terms, that translates into such ideas as tax reform, deregulation, and/or cutting back on government spending. Whatever solutions that Congress decides to kick around in the upcoming days, extending unemployment benefits should not be one of them.

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