Risk-Sharing and Harmonizing Unemployment Benefits to Strengthen European Integration

As Jean Monnet, recognized, often it takes a crisis for the EU to move ahead. This has been the case with the COVID-19 crisis and the launch of the Temporary Support to Mitigate Unemployment Risks in an Emergency (SURE) mechanism providing, for the first time, financial support (loans at convenient conditions) to member states to cover the increase in expenditures on unemployment insurance (UI) and in job retention programs. In spite of its successful subscription[1], it is still early to provide a proper assessment, but not for a rigorous analysis on the potential gains and proper design of a permanent facility. This is what is done in the BSE Working Paper 1330, “On the Design of a European Unemployment Insurance System,” by Árpád Ábrahám, João Brogueira de Sousa, Ramon Marimon, and Lukas Mayr.

Providing insurance and a common UI, but with the right incentives

One rationale for a unified unemployment insurance policy across the European Union is to provide insurance across member countries. Particularly, large shocks can induce more significant and more persistent unemployment rates in some countries than in others. Moreover, individual countries may find it more difficult to provide UI in recessions, without breaking their fiscal mandates, than the whole Union as a whole.

The authors find that a EU-wide lending facility, similar to SURE but targeted exclusively at providing UI transfers during large recessions to individual countries – brings sizeable welfare gains for almost all countries, as compared to countries financing their individual UI policies in isolation, even if with the risk-sharing mechanism ultimately each country covers its own cost, avoiding moral hazard and providing incentives to improve labor markets.

They account for the sizable structural differences across countries, as well as the heterogeneity of their UI policies, but show that in spite of the structural differences it is possible to have an agreement on a common policy among the 16 Eurozone countries of the study. In fact, after harmonizing the UI system across countries (to a common replacement rate and average duration of benefits),  the EU risk-sharing facility can bring even larger gains.

How do you measure a policy that have just temporary started? Develop a model!

The authors set to write a model to simulate different policy scenarios. Crucially, it focuses on unemployment insurance policies that take into account both the savings decisions of workers and their job-searching decisions (being employed, unemployed or inactive). This is important since poorly designed policies might induce excessive saving rates (and low consumption) or deter unemployed workers’ effort when looking for jobs, leading to more people exiting their jobs and more rejected offers.

Their model replicates very closely the main labor market features we see in the data. Notably, countries with high unemployment are those in which the model predicts more people transitioning from employment to unemployment. Additionally, both the persistence of unemployment and the transition from inactivity to unemployment are well-matched for several countries.

Lastly, but not less important, the model matches the fact that the lowest quintile in the wealth distribution holds basically zero to very little wealth. It is this segment of the population that relies more on unemployment insurance during recessions.

Automatic stabilizers might be helpful but can be improved upon

With the model at hand, one may ask how an automatic stabilizer policy similar to SURE may help countries in the union. They find that with such a system in place, almost all workers employed before a large and unexpected shock hits the economy are better off with EU-wide policy than in a scenario where the country needs to finance the increased expenditure on its own. Moreover, the people who gain more from this policy are those who depend more on labor income than on wealth.

Figure 1 Labor Market Rigidity

This policy also brings more welfare gains in those countries with more rigid labor markets  (those in the upper-left corner of Figure 1[2]). This is because the increase in national taxes to fund unemployment benefits on their own would need to be higher in the absence of this fiscal instrument which, nevertheless, is designed not to have persistent transfers across countries.

Considering a uniform policy for member countries

While a Union-wide fiscal stabilizer is shown to have a positive impact on participating countries, it still represents a policy that is not harmonized within all member countries. Thus, thinking of an unemployment insurance policy with a uniform criterion for all workers in the EU has the benefit of not only enhancing further European integration but also bringing significant welfare gains for almost all countries. The authors compare different harmonization policies and settle on an EU-wide fiscal policy that grants a lump sum payment equal to three-quarters of income to those workers that are involuntarily separated from their work. This is a one-time payment for each unemployment spell, with no further disbursement being made before the worker finds another job.

Figure 2. Welfare Gains from the Harmonized UI Policy.

Their analysis shows this policy can have widespread support in almost all countries involved, taking into account a means-tested transfer for low income households, below a threshold calibrated to the existing government transfer programs in the EU countries. This front load payment increases the rate at which unemployed workers look for jobs and the acceptance rate, positively impacting employment. Ultimately, the welfare gains of the EU risk sharing system are found to be higher if the common UI policy is in place, than under the status-quo policy, as shown in Figure 2.

[1] Activated the 22nd of November 2020 with a €100 billon by 29th of March 2022 €91.8 billion had already been provided, with 19 EU countries participating.

[2] Figure 1 is a novel picture of the diversity of euro area labor markets, in terms of the rate of job-arrival offers to non-employed and job separation rates, which together with workers decisions determine the flows between employment, unemployment and inactivity.