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Labour Economics

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									  Labour Economics

          Dr Hamish Low
             Lecture 6

(Office Hour: Wed 24th 11.45 – 1.15pm)
                 Outline
• Costs and benefits of unemployment
  insurance
• Bailey model: saving and search
• Imperfect capital markets
• In-work benefits
          Benefits and Costs of UI
•Consumption Smoothing              • Moral Hazard
(first-best: no income loss while      – search (increases wres,
unemployed)
                                       reduces effort)
                                       – labour supply
•Subsidize search
                                       – layoffs (firms)
   – privately inefficient
    – externality
                                    • Distortions to occupational or
                                    geographic mobility, or
• “Automatic Stabilizer”            investment

• Redistribution                    • Distortions from financing
                   Tradeoffs
• The traditional way to think about the moral
  hazard in unemployment is with search models
  (Mortensen 1977)
• Income maximization (linear utility) implies no
  consumption smoothing benefits
• UI can have benefits in a linear utility
  (equilibrium) search model (eg. if there is an
  externality from search) but it’s not obvious this
  is the central issue.
• Want model where consumption smoothing
  matters, but moral hazard also arises
                           Bailey (1978)
                                         Possible
              $                          Job loss                  No job loss




      wage
                        Saving against
                        job loss
consumption
                                                                               w with UI

                                                                           Job loss
                                                                           occurs

                                                                                      T
                                                    Search     
       • Consumption falls on job loss.
       • Utility loss from consumption partially smoothed over states by
       UI and by saving
       • Unemployment insurance increases search.
                      Time Path of Earnings


w1 1   u   r 

                                    w2 I 

         w2 I 




                                I
                0          T1                 T2
          max u  y1  s    u  y2 ,    1   u  y1  s 
          where
          y2  b  1    yn  

Euler equation:


                  u c1 
                           
                              u c2 ,  
                                           
                                                          
                                             1    u c2no
                                                             no


                   c1           c2                   c2

Imperfect smoothing over states:

                             u c1  u c2 ,  
                                     
                              c1        c2


                                 
                             u c2
                                   no
                                     
                                       u c2 ,  
                              c2
                                  no
                                          c2
   Value of Unemployment Insurance

• Improves smoothing over states, but induces some
  inefficiency

• Gruber (1997):
   – becoming unemployed associated with 6.8% drop in (food)
     consumption
   – if no UI, drop in consumption would be 22.2%
   – 10% increase in replacement ratio, reduces fall in consumption
     by 2.65%
• Hansen and Imrohoroglu (1992):

  – no moral hazard in search:
           optimal replacement ratio of 0.65

  – with moral hazard:
           optimal replacement ratio of 0.15
           welfare cost of unemployment: 0.67%
       Imperfect Capital Markets
• In Bailey and in standard search models, indifferent to
  the timing of income after job loss (perfect credit
  markets?)

• What if unemployed are unable to borrow against future
  earnings?
   – after job loss, two stages: search stage and earnings stage. May
     be unable to smooth consumption (and marginal utility) over
     these stages
                     ucsearch,   u cearning 
                                    
                       csearch       cearning

   – affects incentives to accept a job:
         a job offer appears more valuable because increases current
         consumption, so lower reservation wage
                  Simulated Durations

How long to search for higher wage after becoming unemployed?


       Duration

           0.9                                 credit constrained
                      unconstrained
           0.7

           0.5                             optimal duration
           0.3
                       0.2       0.4     0.6
                                                b
                                           Unemployment benefit


   Are individuals choosing durations that are too short or
   too long relative to optimal (income maximising)?
         0.6



          0.4
  Optimal
replacement
               0.2
    rate                                                            0.4
                                                              0.3
                0.0                                     0.2
                      30
                                40
                                             50
                                                  0.1
                                                         r
                           Age at job loss
                   In-Work Benefits
Net Income, £
   25000
                               Single-Child Household,
                               One earner at min wage
   20000
                with tax credits
   15000


   10000


    5000
                                       Income tax and
                                       income support

                     5000      10000     15000     20000   25000
                                        Gross Income, £
                   In-Work Benefits
Net Income, £
   25000
                               Single-Child Household,
                               One earner at min wage
   20000
                with tax credits
   15000


   10000


    5000
                                       Income tax and
                                       income support

                     5000      10000     15000     20000   25000
                                        Gross Income, £
                   In-Work Benefits
Net Income, £
   25000
                              Single-Child Household,
                              One earner at min wage
   20000
                with tax credits
   15000


   10000


    5000
                                       Income tax and
                                       income support

                     5000      10000     15000     20000   25000

                                        Gross Income, £
        with credit constraints
How long to search for higher wage after becoming unemployed?


       Duration

           0.9       unconstrained,          unconstrained + tax credit
                     no tax credit           constrained +
           0.7                               tax credit

           0.5                           optimal duration
           0.3
                      0.2        0.4   0.6
                                              b
                                        Unemployment benefit
               Reservation Wage


•   Static decision (income maximisation)

               income if return to work


        ys     ys            F a   b

gross income
                                                   unemployment
                                    child care
                                                   insurance
                   tax credit      cost of work
                 (-ve if net tax
                     payer)
   •   Dynamic decision (returns to search)

                increase in lifetime income           increase in lifetime income if
                     if return to work                       keep searching


                                                                      
                                                            y j st 
                                                                     
                y s     y s     F a      b    j t 1    
                                                                 st
gross income
                                                    unemployment
                                      child care
                                                    insurance
                     tax credit     cost of work                     increase in lifetime
               (-ve if net tax payer)
                                                                   earnings from better job
                                                                       match / training

                    Effect of τ: tax credit lowers wres
        with credit constraints
How long to search for higher wage after becoming unemployed?


       Duration

           0.9       unconstrained,          unconstrained + tax credit
                     no tax credit           constrained +
           0.7                               tax credit

           0.5                           optimal duration
           0.3
                      0.2        0.4   0.6
                                              b
                                        Unemployment benefit
                  Implications
• Are unemployment durations too long or too short
  in absence of intervention?
  – no credit constraints: durations may be too long
  – with credit constraints: durations may be too short

• Subsidise search or offer tax credits?




• Analogy to market failures in education? Using
  loans avoids identifying source of wage growth?
               Conclusions
• Unemployment insurance has risk-sharing
  benefits, but increases reservation wage and
  reduces effort in job search
• UI crowds out private saving; only partial
  insurance
• If credit constrained: UI helps consumption
  smoothing and moral hazard effect may be less
  (higher optimal UI)
• In-work benefits: are durations too long or too
  short?

								
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