Unemployment insurance, work disincentives, and the Canadian labour market: An overview

by Miles Corak
Business and Labour Market Analysis Division
Analytical Studies Branch research paper series, No. 062

The major objective of this paper is to survey the economic literature that examines the labour market effects of the Canadian unemployment insurance (UI) program. Our knowledge of these effects has advanced considerably since the last surveys of this kind were written during the early and mid 1980s. As the reform of unemployment insurance promises to be an important priority it is important that policy makers and analysts have available the most recent findings from the academic literature available to them.

I divide this literature into two broad categories: macro-level studies, and micro-level studies. The former is characterized by the use of aggregate time series data to examine the impact of changes in UI generosity on the level of the unemployment rate. In summarizing these studies, I find perhaps contrary to conventional wisdom, that UI has probably not changed the unemployment rate that much if at all, and that at best its effects remain an unresolved issue.

Micro-level studies are much more eclectic. For the most part they are concerned with an analysis of information about individuals in a manner that attempts to recognize the inherently dynamic nature of the labour market as well as the complexity of UI's interaction with it. In reviewing studies of this sort I find that the disincentive effects of UI appear to be concentrated in particular pockets of the labour market: the behaviour of the large majority of the population is not affected at all, but that of a minority is significantly influenced.

I also identify important gaps that remain in our knowledge, the most glaring dealing with the demand side of the labour market. There has been very little attention paid to the manner in which the UI program affects the lay-off and hiring decisions of firms, and the relative sizes of industries.

While I summarize some of the policy implications of the literature surveyed, I begin by noting that this literature offers only half the story needed to devise good policy: it represents an examination of the marginal costs of UI, but those need to be compared to the marginal benefits. Costs need to be weighed against benefits before any rational policy action can be advocated, but an evaluation of these sorts of trade-offs requires an understanding of the goals of the UI program.

Thus, the second objective of this paper is to examine the assumptions of two extreme perspectives that have dominated the UI policy debate: government payments to the unemployed as "insurance" for unemployment, and government payments as an "income transfer" scheme. Each perspective is based upon a different interpretation of the nature of the unemployment, and a different value judgement of how its burden should be distributed. It is important to be aware of these value judgements when an attempt is made to draw implications for policy.

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