Employment cannot recover so long as the government pays people more to stay at home than what they earn from working.
When the CARES act came out many economists expressed concerns about the incentives it would provide to workers with the $600 supplement for unemployment benefits. These worries have already proved true as workers have been asking employers to keep them laid off since they earn more that way.
Now, a new working paper from the Becker Friedman Institute for Economics at the University of Chicago shows this is much more widespread than we many may have originally thought. The authors of the paper find that that 68 percent of the workers who are eligible for unemployment insurance receive benefits that exceed their lost earnings.
What is more, the authors of the paper show that the average benefit is 134 percent of lost earnings with the bottom 20 percent of earners receiving as much as 200 percent of lost earnings. In essence, anyone earning about $1,000 per week or less receives more in unemployment benefits than from working. Basic economic theory tells that it will be hard to see substantial decreases in unemployment until the end of July when the $600 is set to expire.
As Robert Murphy writes in this article, “The theory here is straightforward: when the government subsidizes an activity, other things equal, people will engage in more of it.” In this case, as the government pays people more to stay at home than what they earn from working, we cannot expect most people to start looking for a job when the economy reopens.
We know from the past recession that unemployment did not start to decrease substantially until the unemployment benefits expired. In the article mentioned above, Robert Murphy cites a working paper by NBER and writes that “the abrupt end of unemployment benefit extensions led to 1.8 million additional new US jobs created in 2014.”
It is important to keep in mind that these were regular unemployment benefits, meaning only what the states provide, which are usually about half or less of lost earnings. In the current situation, with people getting paid more than what they earned from working, we should expect the situation to be far worse.
Consider for instance the bottom 20 percent of earners who are receiving benefits equal to twice their lost earnings. These groups of people will have no incentive to go back to work, for half of what they get for staying at home. To be clear, not everyone will have the opportunity to avoid going back to work. Anyone who was furloughed will have to go back to work when they are called back or they will lose the benefits. So, as the economy opens, we may in the early stages see a sharp decrease in the unemployment rate. In fact, we may already have seen this play a role in May, with a reported 2.5 million jobs added. This may continue in June too, but we know, based on the economic theory explained above, that the generous unemployment benefits will dampen the return to work.
Yet, the consequences of this may go beyond what is visible through a simple analysis of how incentives affect our behavior. Consider the people who are currently paid twice what they earned before being unemployed. Many of these people will not start looking for a job any time soon and will likely wait until close to the end of July to do so. The problem is that the more employees stay away from the job market, the harder it is for them to be matched with an employer and find a job. This becomes even more important when one considers a recent paper from NBER where the authors argue that the lockdown will have long-lasting effects on unemployment.
Moreover, the University of Chicago study finds huge distributional differences among industries. For example, food service workers receive the most benefits relative to lost income, while IT workers only receive just over half of their lost income (see Figure 4 in the paper). This means that some industries will have a harder time reallocating workers.
Consider the foodservice industry that is expected to lose as many as 25 percent of its restaurants, according to OpenTable. This means many of these workers will need to find a job in another industry, but as I have argued above, many will not start looking for a job until the end of July.
This is not the full story here, the NBER paper mentioned above, finds that food services have a high portion (about 60 percent) of workers that exhibit the longest duration of unemployment. The authors of this paper argue that the higher the portion of these workers, the harder it is to bring unemployment rates to the natural rate of unemployment (think of this as the pre-COVID-19 unemployment rate).
Yet, the foodservice industry is not the only one in this situation. This analysis can very well apply to construction and many other industries. Hence, the generous benefits from the federal government will further delay the necessary reallocation of labor that is very important for a strong and healthy economic recovery.
One may ask, "But isn’t it a good thing that those who had the lowest earnings get a break and receive some much-needed help?" This is a fair concern, but as I have argued above, this is not the best way to help low-income people. In fact, we may end up hurting them more than helping them in the long run. Remember that these people will find it harder to find a job the longer they wait, and when the $600 extra benefit expires, they may struggle to find a job and suffer more.
The lesson we need to emphasize here is what Frédéric Bastiat called the unseen consequences of a given policy or law. While this policy may have been well-intended, it will likely cause more harm than benefit for the economy as a whole, but it may very well do so even for those who are benefiting now.
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