Panel Paper: The Effect of Unemployment Insurance Extensions On Reemployment Wages

Friday, November 9, 2012 : 1:20 PM
Baltimore Theatre (Radisson Plaza Lord Baltimore Hotel)

*Names in bold indicate Presenter

Johannes F Schmieder, Boston University, Till Von Wachter, Columbia University and Stefan Bender, Institut fur Arbeitsmarkt und Berufsforschung

Does the search subsidy provided by unemployment insurance (UI) help workers find better jobs or does the resulting increased time out of work lead to skill depreciation and lower reemployment wages? This paper investigates this question by exploiting strict age thresholds in the German UI system that determine workers’ maximum potential UI benefit duration. Using a large administrative data set to implement a regression discontinuity (RD) design we show that longer potential benefit durations lead to sharp increases in nonemployment durations while lowering post-unemployment wages. In order to interpret this finding, we present a new theoretical result that shows how the average effect of UI extensions on reemployment wages can be decomposed into a reservation wage effect and an effect coming from changes in the wage offer distribution throughout the nonemployment spell. This decomposition can be implemented using information on how reemployment wages conditional on non-employment durations are affected by UI extensions. We show empirically that reemployment wages conditional on time out of work are not affected by increases in potential durations. Our theoretical result implies that in this case the negative effect of UI extensions on average wages is entirely due to changes in the wage offer distribution over time. Furthermore we can estimate the change in mean offered wages over time, by regressing reemployment wages on nonemployment durations and instrumenting for time out of work with the increase in potential UI durations at the age discontinuity. This IV estimate implies that each month out of work reduces wage offers (and reemployment wages) by 0.9 percent, pointing to very high costs of long-term unemployment. Furthermore about half of the average wage loss of 25 percent of the unemployed in our sample is explained by time spent out of work.