Behavior economics and unemployment insurance: Lessons for policymakers?

A headline only a wonk could love: What behavioral economics can teach us about unemployment insurance.

Talk about tailoring the tease to the audience. Does it get more exciting than this? Well, yes, of course. But for those interested in UI costs and helping the unemployed handle the transition to reemplooyment, the Brookings Institution report is worth reading.

Unemployment insurance is a vital safety net, particularly in bad economic times, but because these benefits are only available to those without a job, ample evidence suggests that it may encourage unemployed individuals to remain jobless for a longer period of time.

Looking at the data and policy tweaks implemented in Hungary, the analysts note,

The current U.S. unemployment insurance program provides benefits for a period typically lasting 26 weeks, after which benefits are usually ended. The standard job search model predicts that beneficiaries are less motivated to find jobs at the beginning of their unemployment spell, but begin to search harder as the prospect of a benefit cut nears. 

People don’t behave the way that model predicts, though.  They search hard at the beginning of their unemployment spell, relax their search activity, and then intensify before benefits are cut.  To better explain how the unemployed search for jobs, Schmieder and his co-authors develop a new “reference dependence” model.  In their view, unemployment benefits are only a fraction of the income earned on the job (the reference point), so the jobless are highly motivated to find new employment at the beginning of their unemployment spell, but motivation falls as they become accustomed to the lower income. As the benefit cutoff date approaches, beneficiaries begin searching harder again, then lose motivation after benefits are cut.

So, what to do?

In 2005, Hungary implemented a two-stepped UI benefit structure, essentially front-loading benefits over the first 90 days, then reducing them substantially over the next 180 days. Under this structure, the total amount of benefits over the 270 day period that an unemployed individual was eligible to receive was not changed, but a person finding employment in the first 90 days would receive more post-reform than they would have pre-reform.

We’re not recommending the reform – we’d like to know more – but we are delighted to see continued analysis and exploration of policy ideas that accomplish better the goal of helping unemployed workers quickly rejoin the workforce.