Monday, August 31, 2009

Human capital and unemployment

Can too much unemployment insurance have severe long-run consequences? That's one of the underlying questions in a famous paper by Sargeant and Ljundquist entitled The European Unemployment Dilemma. In the paper, their task was to explain why European unemployment was so persistently higher than unemployment in the United States. As a second leg to the paper, they identified the long-run consequences of long-lasting high unemployment.

Their paper uses a dynamic search model, and therefore, is highly mathematical. But, for an intuitive flavor of what they do, here's the general thrust of their argument:
  1. Europe had much more generous unemployment insurance (and stronger union power), which led to a persistently higher unemployment rate.
  2. The high unemployment rate means that people spend longer periods of time out of work. During these bouts of unemployment, people lose skills. When working, people acquire skills from learning by doing. In economic lingo, a person's human capital declines when out of work, and rises when the person has a job. Therefore, a society with enduring high unemployment becomes relatively less productive over time.
The paper is a cautionary tale about the long-run consequences of unemployment. In an American economy that is struggling with a long bout of persistent unemployment, Sargeant and Ljundquist's paper warns us that we will feel the consequences of the current recession for some time.

To the extent that being unemployed leads us to lose our ability to work productively, this is a forboding tale. On the other hand, some people might use their time out of work to invest in education or training programs. For this group, being out of work has a silver lining. It can be an opportunity to improve.

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This is the second post in unemployment week on This Young Economist. Economists view unemployed individuals' labor as an idle resource. With this idea in mind, tomorrow's post tackles the question "What does it mean to be idle?"

2 comments:

  1. Just a clarification on what I mean by "highly mathematical"

    The paper really isn't *that* mathematical as far as economics papers go. It is actually a wonderful paper to read.

    But, the paper uses some math that is taught in graduate courses in economics, which would make it hard to understand by anyone who hasn't had the math. Therefore, in the blog-o-sphere, I call it "highly mathematical," but I wouldn't tell that to my economist friends.

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  2. Very good points. Also, the worst part about unemployment insurance is the fact that SO many people take advantage of it. Even if lots of jobs arise, people may just wait to apply for a new one if they can earn partial pay for doing nothing, While other tax payers pick up the tab! Or there may be a good job available for them, but they are waiting (because they are receiving some money from the government) for an even better opportunity.

    The question is, how do you regulate this and make sure people do not take advantage of the system? Unemployment insurance is a good thing to some extent, but I think the government has extended the benefits a little too far.

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