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Martti Hetemäki: Unemployment insurance reform

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Permanent Secretary Martti Hetemäki's (Ministry of Finance) presentation at the Economic Policy Council seminar on Labour Market Reforms, 24 January 2017.

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https://www.talouspolitiikanarviointineuvosto.fi/en/improved-jobs-numbers-will-not-be-enough-to-fix-the-problems-in-public-finances/

https://www.talouspolitiikanarviointineuvosto.fi/en/home/

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Martti Hetemäki: Unemployment insurance reform

  1. 1. Unemployment insurance reform • General remarks • The reform • Required employment rate 24.1.2017/Martti Hetemäki
  2. 2. Kyyrä et al (2016) is an example of excellent and policy relevant research • Policy briefs based on this kind of research would be very useful Recent Finnish reforms motivated by research results • Shortening of the unemployment benefit period • Wage subsidy eligibility based on profiling unemployed persons • Regular meetings with all unemployed persons But further reforms are needed • Unemployment insurance (UI) will be reformed (focus of this presentation) An UI which provides both income security and work incentives is welfare superior to • Basic income , including participatory income, models which reward non-work activities given the need to finance public services and benefits also in the future General remarks
  3. 3. Finland’s employment rate, prime age workers, Q3 in 1990, 2000, 2010 and 2016, % Source: Statistics Finland 35-44 years 45-54 years 25-34 years
  4. 4. Employment rate, %, Q3 2016 Source: OECD Sweden Denmark Finland
  5. 5. Employment rate, men, %, 2016 Q3 Source: OECD UK Germany Sweden Denmark Finland
  6. 6. October August June April February December October August Trend Source: Ministry of Employment and Economy Average duration of unemployment spells, weeks, January 2010 – November 2016
  7. 7. Number of new unemployment spells, persons, January 2010 – November 2016 October August June April February December October August Trend Source: Ministry of Employment and Economy
  8. 8. Unemployment benefit level • High benefit = Good insurance, bad work incentives • Low benefit = Bad insurance, good work incentives Benefit duration • Short benefit = Good work incentives, not enough time to search for a good job • Long benefit = Bad work incentives, enough time to search for a good job E.g. Acemoglu, Daron & Shimer, Robert (1999), Efficient Unemployment Insurance. Journal of Political Economy, 107, pp. 893-928. http://economics.mit.edu/files/3907 Trade-offs in unemployment insurance E.g. Andersen, Torben M. (2016), Incentives versus insurance in the design of tax-financed unemployment insurance. International Journal of Economic Theory, Vol. 12, No. 2, 2016, p. 127-150. https://voxeu.org/sites/default/files/file/DP8025.pdf Cyclical conditions • High benefit = Ok in bad times, too weak work incentives in good times • Low benefit = Ok in good times, too low in bad times E.g. Andersen, Torben M. (2015), Tuning unemployment insurance to the business cycle. IZA World of Labour. http://wol.iza.org/articles/tuning-unemployment-insurance-to-the-business-cycle/long
  9. 9. Traditional way to shorten unmployment duration Time Benefit level
  10. 10. Traditional way to shorten unemployment duration Time Benefit level, Exit rate from unemployment Exit rate goes up before the cut in benefit
  11. 11. 63 129 Benefit if active in previous 3 months The reform - If an unemployed person does not work enough or participate in ALP, a cut in benefit Benefit level Benefit if not active in previous 3 months Duration of unemployment
  12. 12. 63 129 Benefit if active in previous 3 months The reform - If an unemployed person does not work enough or participate in ALP, a cut in benefit Benefit level Benefit if not active in previous 3 months Duration of unemployment
  13. 13. 63 129 Benefit level, Exit rate from unemployment Duration of unemployment Exit rate to activity goes up before end of each 3 month period Incentives to stay active whole the time while benefit level remains high
  14. 14. 63 129 In practice, as currently • The unemployed person informs how much she has worked • The unemployment fund adjusts the benefit level accordingly In addition • The unemployed person informs if and how much she has been in ALP Benefit level Duration of unemployment
  15. 15. 153 months 6 months 5 initial days without benefits instead of 7 initial days without benefits Currently: Average benefit 89.15 of full benefit in the first 3 months Full benefit = 100 After reform: Average benefit 92.25 of full benefit in the first 3 months 92.25 89.15 The reform in practice when focusing on the first two 3 month periods +3½ %
  16. 16. 163 months 6 months Full benefit = 100 After reform Currently After reform if active (old benefit level) 95.35 -4½ % After reform if passive
  17. 17. • Relatively high benefits but improved incentives to work or to be in ALP • Long benefits but improved incentives to actively search for work Change in trade-offs in UI following the reform To take cyclical conditions into account, one can • in bad times increase the supply of ALP because there is less work available • in good times cut the supply of ALP because there is more work available
  18. 18. The reform will be implemented in Finland from October 2017 The new ”sanction” on not being active will not be applied on top of old sanctions • At the same time, current sanctions related to the UI system will be reviewed The work requirement will be relatively short • 18 hours in a one week time or 18 hours during a 4 week period • May be warranted to allow for efficient job search during the first 3 months A subtantial increase in ALP in 2017 • Especially wage subsidies increased Based on the experience from the upcoming reform • Parameters of the system should be adjusted if need be A more efficient unemployment insurance critical for higher employment rate • Employment rate key to sustainable public finances (2nd part of presentation)
  19. 19. Fiscal balance does not depend much on general productivity growth when • general productivity growth determines also public sector real wage growth • real wage growth determines growth in real benefits  Fiscal balance relatively insensitive to long-run productivity (and GDP) growth Required employment rate What is the required employment rate to keep public finances sustainable? Employment rate and dependency ratio determine public finances because • Empoyment rate determines the net tax contribution of working age population • The share of elderly is critical for public health care and pension expenditures
  20. 20. Source: Andersen, Torben (2016), Intergenerational fairness. Bruegel-presentation & EEAG-report. http://bruegel.org/wp-content/uploads/2016/02/Torben-Andersen-Economic-Weakness-and-Demographic-Challenges-Bruegel-Presentation.pdf Lähde: Andersen, Torben M., Giuseppe Bertola, John Driffill, Harold James, Hans-Werner Sinn, Jan-Egbert Sturm and Branko Uroševic, "Chapter 2: Intergenerational Fairness", EEAG Report on the European Economy 2016, 2016, 54-69 https://www.cesifo-group.de/ifoHome/publications/docbase/details.html?docId=19189725
  21. 21. Age dependent net public transfers Age Young Working age Old age 0 Social contract: - Working age population finances young and old age population
  22. 22. Age Lower employment rate Young Working age Old age 0 Lower employment rate reduces the net contribution of working age people Net transfers
  23. 23. In the appendix, the empirical relation between fiscal balance and employment rate is used to derive the required employment rate ER* at which primary balance PB=0. 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 DR 58,3 59,3 60,5 61,5 62,4 63,3 64,2 64,9 65,4 65,9 66,4 67 67,5 68,1 68,7 69,2 ER* 71,1 72,3 73,8 75,0 76,1 77,2 78,3 79,2 79,8 80,4 81,0 81,7 82,4 83,1 83,8 84,4 Required employment rate ER* to keep PB=0 given dependency ratio’s DR development, % Source: Satistics Finland, Population forecast 2015 (DR) and own calculations (ER*) Public finances sustainable if public sector primary balance PB = 0 Appendix derives required employment rate ER* that keeps PB = 0 ER* = aDR, where DR = Dependency Ratio DR = (Young + Old age population)/Working age population PB=0 ensures sustainability if i<g or NB<0, i=intereset rate on debt, g=GDP growth rate, NB=net public debt, which is negative in Finland’s case
  24. 24. Työllisyysaste, julkisen talouden tasapainottava työllisyysasteen nousu ja julkisen talouden tasapainossa pitävä työllisyysaste, kun huoltosuhde kehittyy väestöennusteen huoltosuhteen mukaisesti, % Julkisen talouden tasapainottava työllisyysasteen nousu Julkisen talouden tasapainossa pitävä työllisyysaste Ruotsin työllisyysaste (76 % 2016:1) 81 % in 2025Sweden’s employment rate 2016:Q3 Finland’s required employment rate to keep primary balance PB = 0 Year Source: Statistics Finland and own calculations
  25. 25. Unemployment insurance (UI) reform • Unavoidable trade-offs in UI (income insurance vs. work incentives) • The trade-offs can be alleviated by linking benefits to activity while unemployed The Finnish UI reform • Full benefit only if one stays active in each 3 month period while unemployed • If not active, benefit reduced by 4½ % • Active = 18 hours of work or in active labour market policy (ALP) measures • Cyclical conditions taken into account if more (less) ALP in bad (good) times Concluding remarks Required employment rate • Sustainability of public finances requires high enough employment rate • That rate depends on the share of old age population • An efficient UI needed to finance public services and benefits also in the future
  26. 26. Age Children Working age Old age 0 Public secotor Net Expenditure (NE) NE1 NE2 Public sector Net Income (NI) NI Age dependent net public transfers Appendix: Determining primary balance by employment rate and dependency ratio
  27. 27. Total net expenditure NE = NE1 + NE. NE can be written as (1) NE= c(D+NL), D = population <15 years + >64 years, NL = non employed working age population To keep the analysis tractable, equation (1) assumes that children, elderly and non employed cause equal net cost per capita. However, the elderly are likely to have a higher per s capita net cost than the children (see the figure for the UK in the slide after the next). This is, of course, taken into account in the empirical sustainability analyses. Assuming fixed L/K, where L=employment, K=capital, fixed working hours/L and no productivity growth, GDP can be written as GDP = aL. Using this, NI can be written as (2) NI = fGDP = hL, h=fa, f= net tax ratio of the employed Again, to keep the analysis tractable, we use simplyfying assumptions, such as, that there is no producivity growth. This assumption can be relaxed in an empirical sustainability analysis. However, as is noted in the presentation, if public sector real wages and real benefits follow in the long run productivity, long run public sector finances do not depend on general productivity growth. Dependency ratio is of the form (3) DR = D/(NL+L) Employment rate is of the form (4) ER = L/(L+NL) Using (4) and L=ER(L+NL), (2) can be written as (5) NI = hER(L + NL) Using (3) and D = DR(D+NL), (1) can be written as (6) NE = c(DR(NL+L) + L)
  28. 28. Deriving the required employment ER* to keep primary balance PB = 0 Using (5) and (6), (7) NI/NE = (h/c)ER(L+NL)/(DR(NL+L) + L) = k(ER/DR+ER(L+NL)/L), where k=h/c =k(ER/DR+ER/ER) = k(ER/DR +1) Defining the required employment rate ER* as the employment rate under which the primary balance balances and settting PB = NI-NE=0, i.e. NI/NE=1, in (7), one obtains (8) k(ER*/DR+1)= 1 Then ER* can be written as (9) ER* = DR(1-k)/k Hence the required employment rate ER* is proportional to the dependency ratio DR. The current ER* can be calculated using an empirical releation, according to which a one percentage increase in employment rate improves the primary balance/GDP by 0.4 %-points, i.e. dPB = 0.4dER, where d denotes difference. Using 2015 as the base year for which PB=0, (1-k)/k = 1.22. Hence ER* can be written as (10) ER* = 1.22DR
  29. 29. 0 3 6 9 12 15 18 21 24 27 30 33 1 6 11 16 21 26 31 36 41 46 51 56 61 66 71 76 81 86 91 96 101+ Receipts/spendingin2019-20(£thousand) Age Total spending Education Health Long-term care Tax Welfare Source: OBR Representative profiles for public expenditures and taxes in the UK, £ 1 000
  30. 30. Finland’s depedency ratio, 1865–2065 Source: Statistics Finland

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