Pelosi Insulted by Basic Economic Principle

In a press conference late last week, Speaker Nancy Pelosi addressed legislation before the House to extend unemployment benefits until November 30. Asked if the extension would serve as a “disincentive for people to look for work,” Pelosi dismissed the argument as a “misrepresentation of the motivation for people to be on unemployment insurance” and an “insult to the working people of our country.”
What the speaker calls an insult is a basic principle of economics acknowledged by top officials in the Obama administration. Federal unemployment insurance provides temporary payments to workers who become unemployed through no fault of their own and meet certain other eligibility requirements. While this eases the pain of workers who are laid off, it also increases the unemployment rate. Former Harvard University president Larry Summers, whom President Obama appointed to head the National Economic Council, has explained that such programs contribute to long-term unemployment by providing people with “an incentive, and the means, not to work.” Unemployment benefits, in other words, amount to a subsidy for people who have lost their jobs to remain out of work, enabling and encouraging them to delay finding another job.
The debate among economists is not about whether unemployment benefits generate additional unemployment, but the extent to which they do. Summers cites his and Kim B. Clark’s 1979 study estimating that the existence of unemployment insurance almost doubles the number of unemployment spells lasting more than three months. More recently, University of Chicago economist Bruce D. Meyer found that generous unemployment insurance has “a strong negative effect on the probability of leaving unemployment,” meaning the more people are paid to remain without a job, the longer they do so. He determined that a ten percent increase in the “replacement ratio,” or benefits divided by after-tax income received while employed, increases the length of unemployment spells by roughly 1.5 weeks. He also found that recipients are dramatically more likely to get another job just prior to when their benefits run out.
In 2006, Peter Kuhn and Chris Riddell of the National Bureau of Economic Research compared unemployment insurance regimes in environmentally and demographically similar regions of neighboring Maine and New Brunswick from 1940 to 1991. The Canadian province had dramatically higher long-term unemployment over this period, which the authors largely attribute to Canada’s more generous benefits.
Speaker Pelosi also claimed that unemployment insurance is a “job creator” because it “injects demand into the economy.” By this logic, since people without jobs are more likely to spend what money they have, more generous unemployment benefits lead to greater demand for goods and services, and thus more jobs. While it’s at least plausible that unemployment insurance generates greater demand for workers, the notion that such a program leads to more people working seems to be undermined by empirical evidence. The same Summers and Clark study estimates that if the program were eliminated, the unemployment rate would drop by more than half a percentage point. This is particularly significant given that less than half of the unemployed receive benefits since many do not qualify.
Pelosi is correct that unemployment insurance “helps people who’ve lost their jobs,” but her claim that it “creates jobs faster than almost any other initiative you can name” is misleading inasmuch as empirical evidence indicates that it increases unemployment. Government can create jobs, as Pelosi clearly understands, by expanding the public sector; it can also empower private firms to do so by reducing taxes and regulation. Neither of these avenues entails the adverse incentives of paying people not to work. If the goal of policy is full employment, there are likely much better ways to accomplish this than unemployment insurance, and the drawbacks of this program are not to be rejected out of hand.
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