Labor Market Screening and the Design of Social Insurance: An Equilibrium Analysis of the Labor Market for the Disabled

Abstract

This paper studies the optimal design of social insurance programs for disabled workers by developing and estimating an equilibrium labor search model with screening contracts. In the model, firms may strategically use employment contracts, consisting of wage and job amenities, to screen out the disabled. The optimal structure of disability policies depends on firms' screening incentives, which may distort employment rates and contracts. By exploiting policy changes on the labor demand side for the disabled in the United States, we identify and estimate our equilibrium model to explore the optimal joint design of disability policies, including disability insurance (DI) and subsidies to firms accommodating disabled workers. We find that firm subsidies mitigate screening distortions; at the same time, they interact with DI by reducing the labor supply disincentives it generates. The optimal policy structure leads to a considerable welfare gain by simultaneously making firm subsidies and DI benefits more generous. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.