There are two causes of recorded long-term unemployment in the developed countries. Those
are welfare payments and unemployment insurance. These government assistance programs
contribute to long-term unemployment in two ways.
First, government assistance increases the measure of unemployment by prompting people
who are not working to claim that they are looking for work even when they are not. The work-
registration requirement for welfare recipients, for example, compels people who otherwise
would not be considered part of the labour force to register as if they were a part of it. This
requirement effectively increases the measure of unemployed in the labour force even though
these people are better described as unemployed – that is, not actively looking for work.
Similarly, unemployment insurance increases the measure of unemployment by inducing people
to say that they are job hunting in order to collect benefits. Thus government assistance
programs contribute to long-term unemployment by providing an incentive, and the means, not
to work. Each unemployed person has a «reservation wage» – the minimum wage he or she
insists on getting before accepting a job. Unemployment insurance and other social assistance
programs increase that reservation wage, causing an unemployed person to remain
unemployed longer.
Consider, for example, an unemployed person who is used to making $10.00 an hour. On
unemployment insurance this person receives about 55 percent of normal earnings, or $5.50
per lost work hour. If that person is in a 15 percent federal tax bracket, and a 3 percent state tax
bracket, he or she pays $0.99 in taxes per hour not worked and nets $4.51 per hour after taxes
as compensation for not working. If that person took a job that paid $10.00 per hour,
governments would take 18 percent for income taxes and 7.5 percent for Social Security taxes,
netting him or her $7.45 per hour of work. Comparing the two payments, this person may decide
that a day of leisure is worth more than the extra $2.94 an hour the job would pay. If so, this
means that the unemployment insurance raises the person's reservation wage to above $10.00
per hour.
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