Saturday, July 17, 2010

Unemployment Compensation Stimulates Unemployment

In his weekly radio address, President Obama, urged Congress to increase aid to the unemployed and small business. His rationale is right out of the Keynesian playbook of stimulating A. D. (that is Aggregate Demand, not in the Year of our Lord). Obama said:

The fact is, most economists agree that extending unemployment insurance is one of the single most cost-effective ways to help jumpstart the economy. It puts money into the pockets of folks who not only need it most, but who also are most likely to spend it quickly. That boosts local economies. And that means jobs.

"Most economists" does not include me. In fact, it turns out that it may not even include Larry Summers, one of President Obama's chief economic advisers. Summers co-authored a paper in 1995 explaining that increasing the duration of unemployment benefits merely increased the duration of unemployment.

The chart above from a piece by Keith Hennessey shows that workers get real serious about finding and accepting work right before unemployment benefits run out. The longer we extend the benefits, the longer we remove the incentive to find and accept work. One fundamental principle of economics is that you get more of whatever you subsidize. As is often the case, you get what you pay for. If you subsidize unemployment, you get more unemployment.

This is because it takes away one of the primary incentives for finding work. Paul's admonition was "If anyone is not willing to work, let him not eat" (2 Thes. 3:10). Now certainly not everyone in this current economic environment is unemployed because they are entirely unwilling to work. Massive malinvestment during the boom of the mid-2000s has led to the Great Recession, which requires a tremendous amount of capital restructuring and labor reallocation. Nevertheless, by extending unemployment benefits, we enable people to remain less eager to accept productive work that does appear. As it says in Proverbs 16:26

A worker's appetite works for him;
his mouth urges him on.

Extending unemployment benefits prevents the worker's appetite from encouraging him to obtain gainful employment, and it is productive employment that will truly stimulate the economy, placing us on the road to real recovery.


  1. I know this is about unemployment, but I have noticed something relating this to minimum wage. At my work at a retail store we are understaffed because we don't have the money to pay for more labor. The workers complain because they are worked and pushed beyond their limits and are often overwhelmed.

    I was thinking that if there were not minimum wage laws then we would be able to not only hire more labor, but also reduce unemployment in the process.

    The argument against this is that the minimum wage is put in place to protect the cost of living and that if it was taken away, then people wouldn't be able to provide for the basic necessities of food, shelter, and clothing.

    I am usually stuck at this point because I don't want to argue something that I can not back with sound economic reasoning. Doesn't the cost of living increase for other reasons such as inflating the money supply by the FED?

    Can you decrease/eliminate the minimum wage without changing other policy too? If so will it help or hurt?

  2. Meeting the cost of living is one of the main arguments used by advocates of the minimum wage. However, doing research for a piece on the minimum wage I wrote a few years ago I found that the percentage of minimum wage workers supporting an entire household was extremely small.

    You are correct that the monetary cost of living is in large part determined by FED inflation. As the increase the money supply people spend more, increasing overall prices so that the monetary cost of food, clothing, and shelter goes up. Because of higher prices, political pressure is brought to bear on Congress and the President to raise the minimum wage. If the FED didn't inflate, people would not have to continually push for higher wages just to keep up with the cost of living.

  3. Dr. Ritenour, do you have the article you wrote on minimum wage accessible to the public?

  4. This just passed through Congress and was signed by the President. How upsetting. Individuals now have additional time where they don't have to worry about finding work to pay expenses. Maybe they will watch their favorite TV show Chuck.

  5. Matthew,

    The article I wrote about the minimum wage is now available from a link on my "Other Publications" page. The link is listed under "Selected Editorials" and is entitled, "What You Need to Know about the Minimum Wage." It is the eighth link down in that section.