David R. Henderson  

Summers on Unemployment Benefits

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On today's Forbes.com, I have a piece titled, "Has Bush Heard of Bastiat?" Forbes chose the title, but I think it's a good one. And I'm willing to bet dollars to doughnuts that Bush hasn't heard of Bastiat. I wouldn't be surprised if only a handful of people in the Bush administration have heard of him. More's the pity because Bastiat's view of the difference between a good economist and a bad economist is crucial.

In my article, I quote from Larry Summers's article, "Unemployment," in The Concise Encyclopedia of Economics. In that article, Summers writes:

Consider, for example, an unemployed person who is accustomed to making $15.00 an hour. On unemployment insurance this person receives about 55 percent of normal earnings, or $8.25 per lost work hour. If that person is in a 15 percent federal tax bracket and a 3 percent state tax bracket, he or she pays $1.49 in taxes per hour not worked and nets $6.76 per hour after taxes as compensation for not working. If that person took a job that paid $15.00 per hour, governments would take 18 percent for income taxes and 7.65 percent for Social Security taxes, netting him or her $11.15 per hour of work. Comparing the two payments, this person may decide that an hour of leisure is worth more than the extra $4.39 the job would pay.

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CATEGORIES: Labor Market



COMMENTS (9 to date)
El Presidente writes:

I object to your summation on three accounts.

1. Unemployment benefits of the magnitude you describe still constitute a 45% diminution in income. If we say that a 55% benefit is a disincentive to work, then the 45% reduction in pay is certainly a strong incentive to resume working. Where is that in your analysis? There is an unstated assumption that the baseline for comparison is zero income. While this is plausible, it is not theoretically necessary and should be acknowledged if the analysis is to be thorough and credible. There are alternatives.

2. For many people, their undivided wage doesn't get them all that much in the first place. People are not casually volunteering to be unemployed, especially in our present economic environment. To say that people are rationally choosing to become unemployed because they prefer leisure seems more than slightly tone-deaf.

3. While the meager incentive of unemployment benefits might give a person an opportunity to be more selective about choosing how long to hold out for a better job and a better wage, it cannot cause them to become unemployed in the first place. A person who simply quits is rarely eligible for unemployment benefits. In this way, unemployment insurance does not cause unemployment; if anything, it prolongs unemployment. Perhaps a fine distinction, but an important one.

Addressing macroeconomic concerns, the value of unemployment insurance as an automatic stabilizer deserves at least a little bit of ink.

El Presidente writes:

One more thought:

The marginal decision isn't whether I will be employed or unemployed on an hourly basis. It's whether I will be employed or unemployed, period. It's whether I will earn an undivided wage or receive a divided one through unemployment insurance. That's the decision people are making and the appropriate basis for analysis.

ZapRadon writes:

As someone who's been there and done that, all I can say is Summers is all wet. The example might be valid for someone making 3 times as much, but not for the vast majority. Unemployment isn't enough for rent and utils let alone food and gas for job searches. During the 2001-2003 recession, I lost 40 lbs and was near starvation by the time I found work again, and I'm an engineer. There is a monumental disconnect between reality and what many academics and industry analysts believe.

RubberCity Rabble writes:

Doing a bit of arithmetic with Summers' numbers: the person receives unemployment benefits comparable to a net income of $14,060.80/year ($6.76 X 40 hrs/wk X 52 wks hrs/yr). For working, the person nets $23,192/year ($11.15 X 40 hrs/wk X 52 wks hrs/yr).

You conclude that unemployment benefits are a disincentive to work: "It's not that unemployed people are necessarily lazy; it's that they are rational. They weigh costs and benefits, just as the rest of us do." I don't know how close you are with folks living at the poverty level (see http://aspe.hhs.gov/poverty/08Poverty.shtml). If a single parent with 1 child asks "how do the benfits of living at the $14K poverty level compare to the $23K of benefits my child and I will enjoy if I go back to work?" - working clearly beats unemployment if the person can find that new job that pays the same as the one they had before.

In a time or locale with high unemployment, the number of unemployed can exceed the supply of jobs with pay equivalent to the lost job, so some people will really not have the choice between unemployment vs. returning to the same pay they made before. They must weigh the difficult and usually costly decisions to retrain, relocate, or ratchet down their expectations of maintaining the lifestyle their nominal $15/hr used to afford them. Or they wait and hope conditions improve. The additional 13 weeks of unemployment benefits may not resolve any of those dilemmas; it will help in whatever transition the person has to make.

Dan Weber writes:

If a single parent with 1 child asks "how do the benfits of living at the $14K poverty level compare to the $23K of benefits my child and I will enjoy if I go back to work?" - working clearly beats unemployment if the person can find that new job that pays the same as the one they had before.

Unemployment sounds better to me, since I would instantly lose about half that surplus to pay for child care, and a big chunk of the remainder to job-related expenses like gasoline and eating prepared foods. Plus I wouldn't get to see my kid.

Health care might tip the scales back to getting a job, though. Assuming it's included.

dearieme writes:

The only good economist is a defunct economist.

Jacob Oost writes:

So he's just discussing the welfare trap, something you can find in any economic textbook.
Yup, it exists, and it gets worse the higher the benefits get.

Funny how Obama's "progressive," redistributionist fans don't really understand what his economic advisors are like.

E.J. McMahon writes:

Don't know about Bush, but Ronald Reagan HAD heard of Bastiat. When columnists Robert Novak and Rowland Evans interviewed Reagan early in his presidency, they asked him to list some of his major intellectual influences. The answer, as recounted in Novak's recent memoir:

“Describing himself as a ‘voracious reader,’ Reagan cited 19th-Century free-trade advocates John Bright and Richard Cobden and 20th-Century Austrian free-market economists Ludwig von Mises and Friedrich von Hayek. He also said, ‘Bastiat has dominated my thinking so much.’ Bastiat? Rowly and I had to look him up.”

Anon writes:

Heck, lots of economists haven't heard of Bastiat. I recently observed one (who I don't want to embarrass so I'm using "anon" as my label and being vague on the details) big name economist see a student wearing a Bastiat t-shirt and ask who was on the shirt. When told that the shirt pictured Bastiat, this economist indicated he didn't know who Bastiat was and asked why Bastiat was worthy of being pictured on a t-shirt.

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