Compensating Wage Differentials and the Optimal Provision of Unemployment Insurance

Abstract

Between 1970 and 1987 the number of workers covered by unemployment insurance nearly doubled,' and benefit payments increased from $3.8 billion to $14.2 billion annually. Economists attribute this increased coverage in part for the sizable increase in the long-run (natural) unemployment rate over the same period [17]. The adequacy of unemployment insurance benefits is a major social and political concern, with repercussions extending to individual welfare and to the profits and productivity of American industries. Yet there has been no statistical investigation to test the adequacy of benefit levels, or to determine the net financial burden on firms, taking the wage offset for benefits into account. Viscusi and Moore [22] developed a test for the optimality of social insurance benefits based on the tradeoff between wages and workers' compensation benefits. Their argument states that if benefit levels were adequate, individuals would be willing to trade wages for benefits at an actuarially fair rate, adjusted for the level of insurance loading. If benefits were too low, individuals would be willing to forego more than the efficient amount of wages to increase the level of insurance. If benefits were excessive, an individual would not be willing to pay the efficient rate in exchange for increased coverage. This paper evaluates unemployment insurance benefits using a parallel approach, with further attention given to moral hazard considerations, and using an alternative risk measure that accounts for the average duration of unemployment spells as well as their frequency. The results of this research estimate the price that workers would pay to insure their income against unemployment in the presence of an efficient (competitive) insurance market. That price provides a reference point for implicit insurance rates as established under the existing unemployment insurance program. Related studies have considered the effect of unemployment insurance on wages. Topel [19] used the pooled 1977-80 Current Population Surveys to estimate the impact of unemployment risk on wages, controlling for unemployment insurance (UI) benefits, as well as the effect of UI on the propensity for agents to enter and leave spells of unemployment (on which a large literature exists). He did not, however, evaluate insurance levels in regard to their optimal rates, or consider