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The Results of the Labor-Market Experiment Are In

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The Results of the Labor-Market Experiment Are In

Reducing unemployment benefits reduced unemployment. August 24, 2021
Economy, finance, and budgets

In mid-May, the United States embarked on a labor-market experiment. The results are in: cutting unemployment insurance (UI) benefits led to job gains.

During the Covid-19 pandemic, the federal government had provided enhanced UI benefits, initially set at an extra $600 per week on top of the regular state benefits. The top-up was later pared back to $300 per week, and scheduled to run through September. In addition to the top-ups, the federal government extended the duration of unemployment benefits and expanded benefit eligibility to workers not previously covered under the state UI systems. While these enhanced benefits may have made some sense during the lockdowns in the pandemic’s initial phase in the spring of 2020, by early 2021 most states had experienced strong economic rebounds and businesses were looking to hire.

Many critics (including me) had noted from the outset of the program that the federal benefit enhancements meant that many workers would earn more while unemployed than they did while working, providing a strong disincentive to find a job. However, the unprecedented economic upheaval and volatility during the pandemic made it hard to isolate the role of unemployment benefits from other factors. Indeed, early economic studies failed to identify an effect on employment of the enhanced benefits through the summer of 2020.

But data released in early May proved decisive. On May 7, the April employment report was released, showing job growth far below expectations. On May 10, news broke that March job openings had risen to a record level. The simultaneous signs of strong labor demand by businesses but slowing employment confirmed anecdotal reports of difficulty in hiring and pointed toward labor-supply difficulties. Within days, several states announced that they would be ending participation in the federal unemployment-benefit programs. Eventually, the list of states ending benefits would grow to 26.

Thus began the great labor-market experiment of 2021. The experiment was not perfectly controlled, as the states did not decide to end benefits at random; rather, all but Louisiana were run by Republican governors. Relatedly, the labor-market conditions in May 2021 differed. The ending “red” states generally had fewer public-health restrictions during the pandemic and reopened their economies faster than the continuing “blue” states. As such, the ending states generally had lower unemployment rates and had seen a greater recovery of employment toward pre-pandemic levels than did the continuing states. Nonetheless, the subsequent performance of the labor markets in the two groups of states could show the extent to which the enhanced unemployment benefits were keeping workers on the sidelines.

While it is still early, the results of the experiment are starting to roll in. The first signs of an effect came in unemployment claims, which rapidly declined in the states ending enhanced benefits. While the termination of the federal programs extending the duration and eligibility for unemployment directly led to fewer workers on the total unemployment rolls, the terminating states also saw a sharp reduction in workers on the regular state UI system. The eligibility for these programs was not directly affected by the termination, but saw a cut in the UI benefit amounts only with the end of the $300 per week federal top-up. Between June 5 and July 17, the first four states (stopping benefits on June 12) saw a reduction of 26.3 percent in continued unemployment claims, while the next eight states (ending benefits on June 19) saw a 15.1 percent reduction, while continued claims in the rest of the nation fell only 0.1 percent. The relative declines in unemployment occurred in the weeks around the benefit expiration, consistent with previous research showing that reemployment rates are relatively constant over the duration of an unemployment spell but rise sharply around benefit expiration.

The evidence is clear: reducing unemployment insurance benefits sharply reduced unemployment rolls. And evidence is now emerging that the termination of the enhanced federal benefits has led to a modest boost in employment. Data on employment are less widely available, and constitute a short, noisy sample. But comparing the 22 states that ended benefits in June with rest of the U.S., and comparing the growth rates in the two months after the announcements with the prior two months, offers some evidence on the impact of the policy change.

Across all indicators, I find that the terminating states experienced improved labor market outcomes compared with the rest of the U.S. In these states, employment growth accelerated by more (in both household and payroll surveys) and the labor force grew more rapidly. The relative gains in private employment were even more than in total employment, and employment growth in the leisure and hospitality sector was especially strong. This sector was hit hard by the Covid-19 recession and, due to its low average wages, was likely most affected by the disincentive effects of enhanced unemployment benefits.

More granular data on the leisure and hospitality sector are available from private sources. Looking at daily employment records for a sample of mostly small businesses with hourly workers (largely concentrated in accommodation and food services), I found a notable, but modest, employment effect of the enhanced unemployment benefit termination in the first 12 states ending benefits. Shortly after the termination announcements in mid-May, employment among these lower-wage hourly workers rose by about 1.5 percent on average in the terminating states relative to the rest of the U.S.

While employment is recovering across the country, the termination of the enhanced federal unemployment benefits has provided a modest employment boost. Many other factors affect labor supply—greater child-care duties, continued health fears, possibly changing attitudes toward work—so reducing UI benefits is not a cure for all that ails the labor market. But of these factors, unemployment insurance is the most directly affected by policy decisions. Advocates could previously claim that there was no evidence that the enhanced benefits were restraining job growth. The labor-market experiment of 2021 renders that claim untenable—and shows, once again, that subsidizing unemployment leads to more of it.

Photo by ANGELA WEISS/AFP via Getty Images

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