Krugman's Unemployment Answer Stares Him In the Face

The advantage of working at Princeton is that when you have a question, someone has an answer. So when Princeton professor Paul Krugman wonders how unemployment insurance causes unemployment, as he did in his New York Times column on Monday, he could walk from the Woodrow Wilson School of Public and International Affairs over to the economics building and discuss it with his colleague, economics professor Alan Krueger.

Krueger, former chairman of President Obama's Council of Economic Advisers, concluded in a 2010 paper coauthored with Columbia University professor Andreas Mueller that the more generous are unemployment benefits, the less intense is the unemployed worker's job search.

Unemployed workers increase the intensity of their job search before their benefits will be terminated, the economists found. Not that unemployed workers appear to devote much time to job search. "The average unemployed worker in the U.S. devotes about 41 minutes to job search on weekdays, which is substantially more than his or her European counterpart," according to Krueger and Mueller.

Krugman is concerned because the budget deal that will be unveiled this week might reduce the duration of unemployment benefits to a maximum of 26 weeks, the standard pre-recession level, and harm unemployed workers. Unemployment insurance programs are administered by the states, with the funds coming from employers' contributions to state unemployment insurance trust funds.

The federal government funded the expansion of unemployment insurance benefits to 99 weeks during the recession. Now, unemployment insurance is available up to 73 weeks, depending on the state. On average, unemployed Americans can receive 53 weeks of unemployment insurance, double the pre-recession level.

Expanded federal benefit programs are scheduled to end at the end of 2013. If Congress allows the programs to lapse, the maximum duration of unemployment benefits will go back to 26 weeks.

In a December 3 letter to Representative Chris Van Hollen, Congressional Budget Office director Douglas Elmendorf estimated that extending the benefits through 2014 would cost $26 billion.

The longer the duration of unemployment benefits, the longer people stay out of work. They turn down low-paying jobs even though they are losing job skills from remaining out of the labor force. The longer they are out of work, the more their skills atrophy. It is a vicious cycle leading to more long-term unemployment.

As Harvard professor Larry Summers, former director of Obama's National Economic Council wrote in 1999, "Each unemployed person has a 'reservation wage'-the minimum wage he or she insists on getting before accepting a job. Unemployment insurance and other social assistance programs increase [the] reservation wage, causing an unemployed person to remain unemployed longer."

Now is the time to end expanded unemployment benefits because November's job news was positive. The unemployment rate declined to 7.0 percent in November from 7.3 percent in October, the economy created 203,000 jobs, and the labor force participation rate rose from 62.8 percent to 63 percent.

Congress should use the improving labor market as an opportunity to reconsider eligibility criteria and benefit levels for programs such as unemployment insurance, food stamps, and disability insurance. These programs have ballooned over the past five years, discouraging work. Low-income Americans face a high marginal effective tax rate when they take a job because they have to give up these benefits.

During most recoveries, the labor force participation rate eventually rises. Although the recovery began well over four years ago, in June 2009, the labor force participation rate continues at 1978 levels, despite the increase in November. Fewer workers translate into lower economic growth.

As well as the 4 million Americans on unemployment insurance, over 9 million adults received disability insurance from the Social Security Administration in October 2013, the latest data available. Over 47 million Americans receive benefits from the Supplemental Nutrition Assistance Program (formerly food stamps).

Since the beginning of the recession, eligibility for these programs has increased, and the programs have become more generous.

Unemployment insurance is particularly relevant both because it represents a large share of all benefits paid to individuals and because the dramatic extension of unemployment insurance benefits, from 26 weeks to 53 weeks.

University of Chicago professor Casey Mulligan, author of The Redistribution Recession, published last year, explains that when unemployment insurance pays more, "the reward to working declines, because some of the money earned on the job is now available even when not working. Decades of empirical economic research show that the reward to working, as determined by the safety net and other factors, affects how many people work and how many hours they work."

Programs such as unemployment insurance need to be gradually dialed back to pre-recession levels as Americans enter the labor market and find work. That still leaves eligible Americans with 6 months of unemployment insurance benefits.

There is no magic formula for exactly how to phase out benefits as unemployment declines, but the better-than-expected jobs report for November and the budget discussions underway for 2014 provide a place to start. Perhaps a topic for a Princeton seminar, featuring Professors Krugman and Krueger?