Unemployment Insurance creates unemployment

Dr David Law
Insights Newsletter
8 October, 2021

Work is underway to design an unemployment insurance (UI) scheme for New Zealand. Such schemes are compulsory and require contributions from individuals.

We can expect more details later this year, but some things are safe to assume.

UI will provide much higher benefits than our current welfare system, without many of the same income or asset tests. Initial indications are that UI benefits might replace up to 80% of an individual’s past income if they lose their job.  

You may be wondering what impact UI might have on unemployment. Economists have put a lot of thought and effort into this question over many decades.

There are all kinds of different models to predict how people’s employment decisions are affected by either the introduction of or changes to unemployment insurance. The interesting thing is that they make very similar predictions.

UI can enhance the likelihood of unemployment through influencing the actions and decisions of both workers and employers. For example, a worker at a struggling firm may put less effort into looking for a new job, knowing that if the company fails, they will be eligible for unemployment benefits.

Furthermore, once people start claiming unemployment insurance, receiving benefits might lengthen the period they are unemployed. They might only start looking for a new job when their benefits are close to expire.

Empirical economists test the predictions of models and theories in the real world. Many studies have been undertaken.

A recent survey finds that time spent in unemployment increases with both the level of UI benefits and the maximum length of time they are available.

In France for example, a 2016 study looked at the impact of a significant increase in the maximum length of time that unemployment insurance could be received from 7 to 15 months. Unemployment increased by 2.5 months as a result of this.

The size of the unemployment insurance benefit has an even greater effect on unemployment. Across thirteen studies spanning 5 countries, a 10% increase in UI benefits resulted in a 5% increase in lost work.

While unemployment insurance sounds like a great idea on the face of it, and will undoubtedly benefit some, we need to be aware of its potential costs. Not just in dollars terms but also how it may affect our already well-functioning labour markets.

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