Labor Supply and COVID-19 Unemployment Insurance

Andreas Hornstein, Marios Karabarbounis, André Kurmann, Etienne Lalé, and Lien Ta. "Disincentive Effects of Unemployment Insurance Benefits." Federal Reserve Bank of Richmond Working Paper No. 23-11, November 2023.

The COVID-19 pandemic brought about the largest expansion of unemployment insurance (UI) in U.S. history. The 2020 CARES Act lowered eligibility requirements, increased stimulus amounts, and lengthened maximum benefit durations — roughly tripling the number of unemployed individuals obtaining financial assistance through UI programs. These novel expansions have been credited with limiting the detrimental effects of unemployment during the pandemic. However, assessing the effects of this change on job-seeking and employment is difficult because UI may have effects in opposing directions. On one hand, UI disincentivizes workers from looking for work. On the other, it provides purchasing power to the unemployed, in turn increasing consumption, demand for local goods and services, and demand for workers.

Recent research by Richmond Fed economists Andreas Hornstein and Marios Karabarbounis, along with André Kurmann, Etienne Lalé, and Lien Ta, has attempted to isolate and estimate the disincentive effects of UI by controlling for local demand effects. They found that there are different stories for low-wage businesses and high-wage businesses, as well as for the different UI policies.

To disentangle the countervailing labor supply and demand effects, the researchers used high-frequency employment and wage data and compared the employment responses of neighboring high- and low-wage businesses in the same localities. By examining an environment where it is reasonable to assume that both business types experienced the same labor demand increase from UI expansion, they could attribute any differences in employment between high- and low-wage businesses to disincentive effects, after accounting for other factors.

The authors first examined the gap in the employment recovery between both business types in the same labor market relative to their pre-pandemic levels. They noted a dismal story for low-wage businesses during the time of the CARES Act. After a large initial drop in employment for low-wage businesses relative to high-wage businesses at the start of the pandemic, low-wage businesses began to catch up. But once the CARES Act's $600 weekly supplement was implemented, the employment gap continued to widen until the policy was about to expire.

After breaking down the estimated pandemic recovery gap along business type, the authors found that low-wage businesses experienced a slower recovery of workers post-UI changes relative to high-wage businesses. Lower-paying jobs are more likely to attract unemployed workers who are not UI eligible, but expanded eligibility reduced the number of non-eligible workers. The difference between job acceptance rates at high-wage businesses that are able to attract workers and low-wage businesses that are not increased until the benefit duration was about to expire.

When the three pandemic UI policies were evaluated independently of one another, all resulted in minimal employment losses. Taken together, however, the policies decreased employment recovery significantly. The authors estimated that if the UI policy changes had not been implemented, job recovery would have been faster and employment recovery about an average 4.7 percentage points higher.

The authors suggested, however, that even though UI expansion may depress employment outcomes through the disincentive effect, this effect should not reflect unduly negatively on UI policies. Other unobserved channels, such as stimulated labor demand, can help accelerate economic recovery. They concluded that policymakers should be aware of all implications of UI policies rather than only the net effect, especially for the benefit of businesses that pay lower wages.