Are incentives irrelevant?

Finland has begun an experiment where it will pay unemployed citizens a fixed monthly sum. The idea is based on a 'universal basic income'. Other countries are going to start similar experiments.

The idea of a basic minimum income, regardless of economic activity, is one that is very attractive to those who are concerned with addressing inequality. It is controversial because opponents say it will simply encourage idleness.

Traditional supply side economic theory says that if the difference between in-work and out-of-work income is too small then there is too little incentive to take up job offers. People remain unemployed until a better offer comes along. When the difference is large then the unemployed jump at a job offer, therefore governments have cut the real value of the unemployment benefit sine the 1980's.

Supporters say that it is more important to deal with inequality which has risen continuously since the 1980s. This was not promised by supply side theory which said that the initial the rise in inequality would be reversed due to faster economic growth. (Unkindly some say this is the 'trickle down' effect, but actually they envisaged faster productivity growth and so higher wages throughout the economy.)

Others point to the fact that the system is very cheap to administer. There are no tests, no adjustments (even if the recipient finds work) and so minimal clerical effort. Therefore government expenditure is partly offset by lower costs of administration.

It's something you may want to watch.

The Guardian covers the story here

The new VCE study design has downplayed the study of inequality. However at IB it is an important economic goal. There is an IA in this one that looks at the effects on LRAS and AD. Read the article carefully, I have not put in every important detail here.

'Remove dole payments after sixth months' call presumes a cause

A Queensland LNP MP is calling for unemployment benefits to be ceased to people under 45 after six months. The aim is to reduce government spending so it can be given to those with large superannuation funds instead - a reason sadly beyond our remit here.

The MP suggests that if somebody knows they will cease to get unemployment benefit then they will indeed get a job. This is of course assuming that those who are unemployed are voluntarily unemployed.

Since the 1980's governments have worked to improve incentives to work through supply-side policies. This has included lowering marginal income tax rates, so that people keep more of what they earn, making working more attractive. Governments have also reduced the real value of unemployment benefits to again make work more attractive relative to unemployment.

The theory is often expressed in terms of 'search costs'. Lowering income tax rates and reducing unemployment benefit makes the cost of 'searching' for new work more costly (in an opportunity cost sense) and so workers will therefore accept a new job more readily, probably one which does not match their ideal job, but it gets them back to work. This would be seen as an increase in economic efficiency.

There are a couple of issues with the MP's proposal. Firstly there is the tricky issue of involuntary unemployment (caused by structural or cyclical factors). The proposal will strand those who genuinely cannot find work. They will most likely have to move on to other benefits because their income is so low, meaning the savings to government will be minimal anyway.

Secondly there is the impact on the distribution of income. The unemployed are, by definition, the lowest income earners and this proposal makes them even worse off. The people who would benefit from the MPs proposed use of money saved would be from the higher income deciles, those with large superannuation savings. The effect on the distribution of income would be to make it more unequal (a higher gini co-efficient).

The New Daily covers the story here

This story has application to the goals of macroeconomic policy and their conflicting nature (equity vs efficiency). Both IB and VCE students can use this as an example of policy.