Does a reduction in benefit payment duration increase employment?

1. Does a reduction in benefit payment duration increase employment? Evidence from the German “Hartz Reforms” ISEO Summer School 2012 Felix König - London School of Economics

2. Content • The unemployment crisis • The German labour market and reform • A simple search model • The effect of the labour market reform

3. Crisis German labour market Model Reform results Inequality The unemployment crisis

4. Crisis German labour market Model Reform results Inequality Unemployment duration as % of the total labour force OECD Employment Outlook 2011 Rising long-term unemployment, even in flexible labour markets

5. Crisis German labour market Model Reform results Inequality Unemployment during the crisis OECD Employment Outlook 2011

6. Crisis German labour market Model Reform results Inequality Questions of this presentation • What is the reason for the German success? • What can be done to tackle high unemployment rates? • Is Merkel’s labour market reform agenda for Europe non-sense?

7. The German labour market

8. Crisis German labour market Model Reform results Inequality “Sick man of Europe” German unemployment rate in % Peter Hartz OECD quarterly Data

9. Crisis German labour market Model Reform results Inequality The “Hartz Reforms“

10. Crisis German labour market Model Reform results Inequality A job miracle? German unemployment rate in % Peter Hartz OECD quarterly Data Falling unmployment since Q1 2006

11. Crisis German labour market Model Reform results Inequality A job miracle?

12. Crisis German labour market Model Reform results Inequality Does this mean Mrs. Merkel is right?

13. Crisis German labour market Model Reform results Inequality Duration of unemployment benefit Three changes allow for identification

14. Crisis German labour market Model Reform results Inequality A difference in difference framework Reasons for being in the treatment group: • Older than a comprable individual • More work experience than a comprable individual • Timing of work experience at an unfortunate point in time

15. Crisis German labour market Model Reform results Inequality Difference in Difference assumptions before yit1   = ci +λt + uit after yit+1  = ci + λt+1 + α + uit+1 Affected Non-affected before yjt1   = cj + λt +ujt after yjt+1  = cj + λt+1 + ujt ∆ yit+1 = λt+1 – λt +α+∆uit+1 ∆ yjt+1 = λt+1 – λt + ∆ujt+1 Need common trend for identification

16. Crisis German labour market Model Reform results Inequality Common trend assumption

17. Crisis German labour market Model Reform results Inequality In a DID regression set up yit = θt + Xit'β + δ After + γ Treated +μ(A*T) estimates -8.4 2.1 -1.7 White standard errors(0.7) (0.5) (0.7) Covariates: monthly time dummies, age dummies, education dummies, work experience dummies and a gender dummy Unemployment duration in months

18. Crisis German labour market Model Reform results Inequality Effect of UI payment duration reform • A one-week reduction in BPD leads to 1.32 days reduction in the unemployment duration • The average unemployment spell length decreased by about 9 days • This amounts to 37,5 % of the decline in spell duration in Germany since 2006

19. So cutting benefit payments is a success story?

20. Crisis German labour market Model Reform results Inequality Labour market flows Elsby, Smith, Wadsworth (2010) Change in unemployment not necessarily due to employment

21. A simple search model Objective function: (roughly following Mortensen 1977) c: search cost in units of consumption s: search intensity wR: reservation wage U: value func. of being unemployed b: benefits λ(s): rate of job offer arrivals ( λ’>0 & λ’’<0 ) u: instantaneous utility W: value func. of working s*: threshold of search activity, below it a person is considered inactive FOCsevaluated in the initial period of unemployment (U = UT): 1. 2. Behaviourchangesasbenefitexpiryapproaches

22. Crisis German labour market Model Reform results Inequality Stylised time pattern of the exit rate Exit rate from unemployment Exit rate Job finding rate Job finding + becoming inactive T Benefits expire T Time

23. Crisis German labour market Model Reform results Inequality Estimating the exit rate The hazard rate is the probability that an individual leaves unemployment in a given time interval (months in this case):

24. Crisis German labour market Model Reform results Inequality Does this mean Mrs. Merkel is wrong?

25. Crisis German labour market Model Reformresults Inequality Conclusions about spell duration Unemployment duration Effect on the treated • Unemployment duration was reduced by 1.7 months • The time to find a new job fell by 1.3 months • But only 17% of the unemployed affected Reform -7 days -2 days -24 days -15 days Total change Matching efficiency Inactivity Residual

26. Refrences • Card, Chetty, & Weber. (2007). The Spike at Benefit Exhaustion. American Economic Review, 97 (2), 113-118. • Mortensen. (1977). Unemployment Insurance and Labour Supply Decision. Industrial and Labor Relations Review, 30 (4), 505-517. • OECD Employment Outlook 2011 • Socio-Economic Panel (SOEP), data for years 1984-2009, version 26, SOEP, 2010 • van-Ours, & Vodopivec. (2006). How shortening the Potential Duration of Unemployment Benefits Affects the Duration of Unemployment: Evidence from a Natrual Experiment. Journal of Labour Economics, 24 (2), 351-378.

27. Reply to questions: • Question: Maybe the affectedgroup takes different jobs compared to the unaffected(e.g. due to training differences among age groups). The common trend assumption might therefore fail. • Reply: 1. The responsiveness to shocks before 2006 can be tested directly. Such worries are unwarranted according to previous slides. 2. For differential shocks that only occur after 2006 can only do indirect testing. Consider Industries with greatest share of job creation for the two groups. Four of the top five job creation industries are identical. No other industry creates more than 5% of jobs. Hence differential developments across industries are unlikely to bias the results.