Benefit systems that aim to moderate the harmful effects of unemployment may also raise the unemployment rate and hence increase the need for the social safety net they are intended to provide. By raising wages and discouraging job search, they generate inefficiencies and inequalities in their own right and also exacerbate the labour market failures highlighted by the efficiency wage, insideroutsider and union theories. The skills of the long-term unemployed erode and they become increasingly discouraged and stigmatized in job search as they remain unemployed for longer periods. They have little opportunity to acquire firm-specific skills, so training them is associated with a poaching externality, while they also face above-average credit constraints that prevent their acquisition of efficient amounts of training.

In Discussion Paper No. 930, Programme Director Dennis Snower proposes a `benefit transfer programme' to allow the long-term unemployed to exchange part of their unemployment benefits for vouchers entitling firms that are willing to hire them to employment subsidies. This voluntary scheme could reduce long-term unemployment and help to equalize employment opportunities. It would not induce inflation, on which the long-term unemployment rate has little influence, and the vouchers would also reduce labour costs. Nor would it entail any extra cost to the government, since the employment subsidies involved would otherwise be spent on unemployment benefit. It would also provide an automatic stabilizer, since any fall in unemployment would lead to a corresponding fall in the funds available for subsidies. Offering vouchers of higher value to firms that provide training could also overcome market failures in its provision, since firms would clearly seek to match training as closely as possible to available jobs, unlike training programmes provided by government. Firms would also have greater incentives to move into regions with high unemployment and retrain the local labour force, to take advantage of their greater endowments of training subsidies.

Converting Unemployment Benefits into Employment Subsidies
Dennis J Snower

Discussion Paper No. 930, March 1994 (HR)