Lowering unemployment

Posted: Dec 16, 2003 12:00 AM

On Sunday, the extended unemployment compensation program will expire. Normal benefits last for 26 weeks. But during recessions, Congress usually extends these benefits by an addition 13 weeks, for 39 weeks total. The latest recession is no exception. Extended benefits were implemented in March 2001 and renewed twice. But on Dec. 21, the latest extension expires. This means that a maximum of 26 weeks will go back to being the case, except for those already receiving extended benefits.

Needless to say, Democrats are up in arms because Republicans failed to renew the extended benefits program before Congress left town. Rep. David Obey, D-Wisc., spoke for most in his party when he attacked the "Scrooges that are running the other party" for letting extended benefits expire just before Christmas. Rep. Charles Rangel, D-N.Y., said the action (or inaction) "borders on being immoral."

There is no question that the timing could have been better. But extended benefits had to expire sooner or later, and I doubt there would ever be a time when Obey and Rangel would not try to score some political points over it. Indeed, a case can be made that extended benefits should have been allowed to expire before now. That was the plan a year ago, but at the last minute the White House panicked and demanded a further extension, making Republican leaders in Congress look like the bad guys.

The basic rationale for extended benefits is that the average duration of unemployment rises during recessions. Since 1970, the median duration of unemployment has averaged 8.2 weeks in the year after a recession and 6.6 weeks at other times. In November, the median duration of unemployment was 10.4 weeks. This means that the vast majority of unemployed never come close to exhausting regular benefits.

Economists have long recognized that unemployment insurance plays a valuable role in encouraging workers to accept greater flexibility in the labor market. This flexibility is essential for economic growth, but also has the effect of destroying jobs. Fortunately, in a dynamic labor market such as we have here in the United States, it usually creates more than enough new jobs for all those that are lost. In a typical quarter, about 8 million jobs are lost and another 8 million jobs are created, according to the Bureau of Labor Statistics.

But unemployment compensation also has an economic cost. For one thing, it encourages businesses to lay off workers faster and more often than they otherwise would. At the same time, unemployed workers are encouraged to extend their job search, rather than taking the first job they can get. This raises the average rate of unemployment without generally improving the quality of jobs ultimately obtained by the unemployed.

Economists have also isolated the effects of extended unemployment benefits. Since many workers wait until their benefits are almost exhausted before taking a new job, the effect of extending benefits beyond 26 weeks simply extends the date when they have to take a job. One estimate concluded that for each week benefits are extended, the average duration of unemployment increases by about a day.

Forcing a worker to take a job that he may not want may seem cruel, but the alternative can be worse. In Europe, every country has unemployment benefits more generous than they are here. It is not uncommon for benefits to replace 80 percent to 90 percent of gross wages, compared to 50 percent to 70 percent in the United States. Standard unemployment benefits in Europe typically last for a year, with a number of countries allowing people to receive them for up to 5 years. In Belgium, they never lose benefits.

But the cost of this compassion is high. Taxes are vastly higher, and so is the unemployment rate. In Belgium, the current unemployment rate is 11.6 percent. Italy, Germany and France all have rates over 9 percent. Europe as a whole has an unemployment rate of 8.5 percent, compared with 5.9 percent here.

Thus, ironically, elimination of extended unemployment benefits will almost certainly reduce the unemployment rate. The House Ways and Means Committee estimates that it will bring the rate down by half of a percent below what it would be if extended benefits remain in place. The Council of Economic Advisers estimates 0.3 percent.

This could be important because the unemployment rate is generally considered to be the most important economic statistic from a political standpoint. The unemployment rate is falling due to business expansion and economic growth, but it may not fall quickly enough to defuse it as a political issue next year. If elimination of extended benefits reduces the rate a further 0.5 percent, it means that the unemployment rate could be below 5 percent on Election Day.