Productivity insurance: the role of unemployment benefits in a multi-sector model

By David Fuller, Marianna Kudlyak and Damba Lkhagvasuren

http://d.repec.org/n?u=RePEc:fip:fedrwp:13-11&r=dge

We construct a multi-sector search and matching model where the unemployed receive idiosyncratic productivity shocks that make working in certain sectors more productive than in the others. Agents must decide which sector to search in and face moving costs when leaving their current sector for another. In this environment, unemployment is associated with an additional risk: low future wages if mobility costs preclude search in the appropriate sector. This introduces a new role for unemployment benefits—productivity insurance while unemployed. Analytically, we characterize two competing effects of benefits on productivity, a moral hazard effect and a consumption effect. In a stylized quantitative analysis, we show that the consumption effect dominates, so that unemployment benefits increase per-worker productivity. We also analyze the welfare-maximizing benefit level and find that it decreases as moving costs increase.

While moral hazard issues make unemployment insurance less attractive, the argument pushed by Acemoglu and Shimer that an unemployment insurance scheme allows workers to search for better matches becomes important here. The difference here is that instead of waiting for a stochastic process to deliver a good match, here workers can choose to move between sectors, sectors being defined loosely, such as location, industry, or occupation. A crucial parameter is then the cost of moving which can have a major impact on the average productivity in the economy.

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One Response to Productivity insurance: the role of unemployment benefits in a multi-sector model

  1. David Fuller says:

    Thanks Christian for discussing our paper!

    The cost of moving is indeed an important parameter. Along these lines, one interesting feature of the model is the following: an increase in moving costs is “observationally equivalent” to a decrease in productivity. When moving costs increase, fewer workers search in the ideal sector for their particular skills. This lowers average productivity, and would look like a negative productivity shock to an econometrician.

    Given this, we believe there may be some interesting future research looking at this issue in a business cycle context. These issues may be quite relevant for the most recent U.S. recession and subsequent recovery.

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