The Labor Market Implications of Unemployment Insurance and Short-Time Compensation

Unemployment insurance is a policy instrument designed to help alleviate the costs to individuals of losing their jobs for reasons beyond their control.It does more than that, however.Economic theory and empirical evidence demonstrate that the presence of unemployment insurance and the type of system adopted can have important effects on many aspects of the labor market allocation process, including wages, hours per worker, firm size, and both the frequency and the duration of unemployment.This leads naturally to debate over how to design an efficient unemployment insurance system.I intend to focus on one key question in this debate: How does unemployment insurance affect the decision by employers to utilize either temporary layoffs or work-sharing?The answer depends on the way in which unemployment insurance benefits are paid and the way in which taxes are levied to finance these benefits.In particular, I consider two alternative systems for paying unemployment insurance benefits.In one system, workers receive benefits if laid off but nothing if their hours are cut back while they remain employed.In the other system, workers are not only paid benefits if laid off but are also paid a prorated fraction of these benefits, referred to as short-time compensation, if they remain employed but have their hours reduced.These two systems are not merely theoretical abstractions, but correspond to the way in which benefits are The Editorial Board for this paper was John H. Boyd, V. V. Chari, Harold L. Cole, and Martha L. Starr.actually paid in different countries.In the United States and in Canada, at least until recently, workers have had to be unemployed to collect unemployment benefits, while shorttime compensation has been used for some time in many European countries, including Austria, Belgium, Denmark, France, Germany, Italy, Luxembourg, the Netherlands, Norway, Sweden, and the United Kingdom (Best and Mattesich 1980, MaCoy andMorand 1984). 1 It may be argued that the North American system, without short-time compensation, provides an incentive for the use of layoffs rather than work-sharing during economic downturns.Under the European system, which has short-time compensation, when economic conditions deteriorate, instead of laying off 20 percent of its work force, for example, the firm could reduce its workweek from five to four days and have its *This paper includes excerpts from a paper published in the Journal of Political Economy (December 1989, vol.97, no.6, pp.