Effects of a European Unemployment Insurance

, by Dirk Neumann, Mathias Dolls

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Effects of a European Unemployment Insurance

The Great Recession of 2008/09 and the resulting debt crisis revived a debate about deeper fiscal integration in Europe. At the moment, especially a common unemployment insurance scheme for the Eurozone is discussed. The idea is that such a scheme could cushion the impact of economic crises if national member states are not sufficiently able to fulfill this function. However, what could be the actual design and the effects of a European unemployment insurance? And what are the risks?

The Eurozone is often considered to be an atypical monetary union because monetary policy is decided at the central level while fiscal policy is carried out at the member state level. This might lead to two problems. First, a joint monetary and interest rate policy can be too restrictive to cushion unexpected economic shocks in single countries. Second, national fiscal policy might be unable to decrease taxes and increase benefits during an economic downturn when countries loose access to private capital markets and can thus not issue debt. Both have been experienced in the recent crisis. Since Van Rompuy’s call for a European “fiscal capacity” and the European Commission’s ‘blueprint for a deep and genuine economic and monetary union’ in 2012, it is therefore discussed whether to introduce elements of a common fiscal policy for the Eurozone. Here, a European unemployment insurance (EUI) that partly replaces national systems has become subject of intense debate. Proponents stress that a joint EUI would stabilize total demand in the participating countries in times of crisis. In contrast, objectors argue that such a system could already transform the Eurozone into a transfer union, i.e. leading to permanent redistribution across countries.

Main effect: stabilization of household incomes

In a recent study, we have examined how different versions of a European unemployment insurance would have affected households in the 18 Eurozone member states between 2000 and 2013. In the baseline simulation, the unemployment insurance is designed such that newly unemployed individuals will automatically be covered by the EUI. 50 per cent of the recipient’s last income level are then paid for a duration of twelve months. National governments could still decide to pay benefits on top of this level. We find that such a scheme could have been implemented with a relatively small annual budget, namely 49 billion euros per year on average over the period 2000 to 2013, financed by a uniform contribution rate across member states of 1.57 per cent on employment income. The main result is that household incomes would have been stabilized in particular at the beginning of the recent economic crisis. However, this effect would have diminished the longer the crisis lasted as the share of (non-eligible) long-term unemployed was rising in the majority of member states.

Limited cross-country redistribution

Would such a EUI scheme lead to permanent transfers across countries as some critics argue? While the scheme does not lead to permanent redistribution per se as only short-term (rather than structural, long-term) unemployment is insured at the central level, our calculations show that a small number of member states would have been net contributor or net recipient in each year of the simulation period. Largest net contributors are Austria, Germany and the Netherlands with average yearly net contributions of 0.2-0.42 per cent of GDP, while Latvia and Spain are the largest net recipients (average yearly net benefits of 0.33 and 0.53 per cent of GDP). Yet, alternative designs could address this problem. In general, schemes with lower coverage ratios and generosity levels generate smaller cross-country transfers, but also reduce desired insurance effects. Additionally, one could think of a benefit scheme which is activated only if the economic shock reaches a certain level, e.g. a certain increase in the unemployment rate. Our study shows that under such a system, no member state would have been in a permanent net contributing or receiving position. With 21 billion euro per year, the overall budget and thus the amount of cross-country redistribution would have been less than half as large as under the scheme in the baseline.

Risk of manipulation

Of course, simulations like these can only be performed under various simplifying assumptions; especially behavioral issues cannot be easily addressed with such calculations. For instance, a common EUI could undermine incentives for national governments to address structural weaknesses of the labor market. Though, under a scheme as presented above, i.e. focusing on short-term unemployment, national governments would still bear the cost of long-term unemployment. Additional concerns relate to administrative manipulation and adverse incentive effects at the individual level with regard to job search, labor supply and migration. Both aspects could be partly addressed through a careful design. Furthermore, one should keep in mind that labor market institutions and the design of national unemployment systems greatly differ in Europe while a EUI would require a political compromise in terms of a certain harmonization of these institutions. Finally, there is no legal framework yet for a EUI scheme.

In sum, a EUI can certainly be considered as a serious option to improve resistance against future economic crises in the Eurozone. The ongoing debate will have to address the benefits and drawbacks in a comprehensive manner and other forms of fiscal stabilization need to be explored as well. In any case, a EUI will rather be a long-term project and the key requirement a prior agreement on fiscal risk-sharing in the Eurozone between all member states.

Since its start in 2008, the European Union has been chiefly preoccupied with managing the economic and financial crisis. So far, the problems involved have not been solved. In its new series, treffpunkteuropa.de presents five alternative ways to overcome the crisis.

Link to study: http://ftp.zew.de/pub/zew-docs/dp/dp14095.pdf

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