Fighting Unemployment With a Stick

From the Wall Street Journal | July 12, 2010 | By Phil Izzo

As the U.S. struggles with the
problem of persistent long-term unemployment, a study of incentives in
the Netherlands suggests a stick is more effective than a carrot.

In their paper “Carrot
and Stick: How Reemployment Bonuses and Benefit Sanctions Affect Job
Finding Rates,” Bas van der Klaauw of VU
University Amsterdam and Jan C. van Ours of Tilburg
University, Netherlands, examine the effects of both positive
and negative financial incentives on the long-term jobless in Rotterdam.
In the early 2000s the city ran a program that provided reemployment
bonuses for job seekers who were able to find a job and hold it for at
least six months. At the same time, benefit recipients who didn’t
actively look for work, or otherwise failed to comply with eligibility
requirements, would be subject to a temporary reduction in their
benefits.

“Our main findings are that reemployment bonuses don’t seem to have
worked, while benefit sanctions increased the job finding rate
significantly,” the economists write.

Van der Klaauw and van Ours note an earlier study in the U.S. that
showed a positive effect from reemployment bonuses, but that bonus was
focused on people that were unemployed for short periods of time. The
Rotterdam study only looked at welfare recipients who are unemployed for
more than a year, suggesting bonuses are less effective for the
long-term unemployed.

Currently, U.S. lawmakers continue to debate whether
to extend unemployment benefits. Some have suggested that the
extension offers an incentive to keep the unemployed from accepting
available jobs, while others argue that a dearth of jobs is the main
factor keeping people on the unemployment rolls longer. The study
doesn’t take a stand on whether to extend benefits, but it does suggest
that monitoring recipients eligibility increases their chances of
finding work.

“Our findings that a stick works while a carrot doesn’t may be
related to present-bias of some workers,” the economists write. “To the
extent that some welfare recipients are present-biased an incentive
scheme that requires immediate search effort in exchange for delayed
rewards in terms of a future bonus may not be an effective scheme.
Benefit sanctions breaking the present bias by imposing immediate costs
to lack of search effort might indeed be an effective and welfare
improving scheme.”

Van der Klaauw and van Ours also point to previous studies that add
one caveat: those who face benefit cuts also face reduced
post-employment earnings. “Actual benefit reductions lower the quality
of post-unemployment jobs both in terms of job duration as well as in
terms of earnings. For unemployed workers the net effect of a benefit
sanction on postunemployment income is negative. Over a period of two
years after leaving unemployment workers who got a benefit sanction
imposed face an income loss equivalent to 30 days,” they write.