The Longterm Effects of UI Extensions on Employment

The effect of extending the duration of unemployment insurance (UI) benefits on nonemployment duration is a hotly debated question. The vast majority of the literature (e.g., Lawrence Katz and Bruce D. Meyer 1990, Johannes F. Schmieder, Till von Wachter, and Stefan Bender 2012) [henceforth SVB]) analyzes the effect of extensions in UI durations or increases in UI benefits on the initial nonemployment spell. This may lead to an understatement of the cost of UI extensions, if such extensions increase the incidence of nonemployment beyond the initial spell, as would be predicted by models of stigma, skill depreciation, or supply-side hysteresis (e.g., Olivier J. Blanchard and Peter Diamond 1994, Thomas Lemieux and W. Bentley MacLeod 2000). On the other hand, these estimates may overstate employment effects if longer initial spells tend to reduce future incidence of nonemployment. This might arise because of an increase in individual labor supply, for example due to lower income. In addition, with a finite lifetime (or a finite follow-up period) the nonemployment effect can also decline mechanically. This can arise since at a given, say, monthly probability of being unemployed, individuals with longer initial spells accumulate less time in nonemployment due to a shorter remaining lifetime. Despite these alternative hypotheses, little is known about the longer-term effect of UI extensions on employment.