College of Arts & Sciences

arts&sciences

The Benefit of Benefits

By Jessica Ullian

There’s an economic theory called “moral hazard” that cautions against taking financial responsibility for another person’s risk. For a contemporary quandary, consider unemployment benefits: last year, as Congress debated whether to extend benefits during the recession, opponents of the plan argued that more benefits remove a job-seeker’s incentive to actually go out and find work.

Economist Johannes Schmieder received a Peter Paul Career Development Award to fund his research on the effects of unemployment insurance. Photo by Cydney Scott

Moral hazard has caused a lot of controversy in the current recession, incensing conservative commentators, contributing to a Congressional deadlock, and even spawning a new nickname for America’s unemployed: the “99ers,” or people who’ve exhausted the full 99 weeks of extended unemployment benefits. The trouble is, in our current economic climate, it doesn’t apply, according to Johannes Schmieder, an assistant professor in the Department of Economics. In a collaboration with researchers in New York and his native Germany, Schmieder tapped into a treasure trove of labor statistics to measure the effects of unemployment insurance, and his finding turned the moral hazard on its head. Schmieder found that during a recession, an extension in unemployment benefits actually has less effect on the unemployment rate than it does during an economic boom.

“In Congress, Republicans were saying that an unemployment insurance extension means people will stay unemployed forever,” says Schmieder. “But the magnitude of it changes in a recession, and the moral hazard is much less. If you want to offer benefits to people who need them, it’s a nice justification.”

Schmieder, who recently received BU’s prestigious Peter Paul Career Development Award to fund his research, tapped into his homeland’s comprehensive social security data for this project, which offered more than one billion individual observations to examine. The unemployed population in Germany, he says, is very similar to its U.S. counterpart: longtime workers laid off after plant closings or company-wide cutbacks.

The data allowed Schmieder and his collaborators to make an empirical observation about the effect of unemployment insurance in various economic climates, and the results were surprising: while the moral hazard holds up in a strong economy, in a recession it’s actually far less.

That’s not to say the system is flawless; if anything, Schmieder’s results underscore the need for change. and his more recent findings offer bleak news for the unemployed, even those with benefits: workers who received unemployment for 18 months, as opposed to 12 months, eventually found lower-paying jobs.

Schmieder sees several possible explanations for the results, ranging from employer bias against unemployed job applicants, to the onset of depression and health problems that lead to a loss of skills. There’s also less accountability now: in the U.S., many states have replaced one-on-one meetings with an unemployment counselor with an automated phone system, eliminating or reducing job training and résumé help.

One thing, Schmieder says, is certain: even with the reduced moral hazard, the focus should be on improving benefits, not merely extending them.

“We should think about changing unemployment insurance, with so many people looking for jobs,” he says. “The system should help people find jobs. Now, it’s going in the opposite direction.”