CFCM 17/02: Welfare benefit reforms and employment

Summary

This theoretical paper compares the effects on employment, income and welfare of two income support policies: unemployment insurance and income subsidies. The authors assume that these policies target low skill workers only, and investigate whether proposals of replacing unemployment insurance with a guaranteed minimum income are economically sound.

In the low skilled sector, unemployment is obtained by assuming that workers are willing to supply labour only if the wage when employed is higher than what they would obtain when unemployed (reservation wage). The latter depends on the unemployment insurance benefit (UI) and on the basic income support (BI). The authors show that employment is more responsive to changes in UI than to changes in BI and, that reducing unemployment insurance benefits in favour of income subsidies reduces employment in general equilibrium. This is due to some fiscal externality on gross and net wages imposed by the balanced budgets for each program.

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Authors

Marta Aloi, Teresa Lloyd-Braga and Manuel Leite-Monteiro

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