European unemployment re-insurance could absorb up to 25% of income losses in recessions

A European unemployment re-insurance system could absorb an average of 15-25 percent of income losses caused by rising unemployment in deep recessions, but various arrangements would need to be made in order to avoid negative incentive effects, according to new research from EconPol Europe.

The research, carried out by EconPol Europe scientific co-ordinator Mathias Dolls, is the first evaluation study to assess the importance of different stabilization channels of an unemployment re-insurance scheme for the euro area. It comes following a proposal by Olaf Scholz, the German Finance Minister, for an unemployment stabilization fund in October 2018 and recent comments by European Commission President Jean Claude-Juncker. Juncker said he is in favour of European unemployment insurance but warned that it must not be carte blanche for countries who find themselves in difficulty as a result of lack of reform.

Another concern besides potential moral hazard is that such a scheme could create an unfair system in which some states become permanent beneficiaries, with others providing permanent transfers. The research from EconPol Europe shows how certain features of the re-insurance might mitigate these concerns.

Explains Dolls: “A re-insurance scheme should provide support to member states only during severe recessions. The activation rule of the considered re-insurance contains a double condition that needs to be met for transfer payments to be triggered. Member states receive a one-time transfer from the scheme if unemployment is above its long-term average and the year-on-year increase in the unemployment rate exceeds a certain threshold.”

The paper – based on simulations of household micro data for the period 2000-2016 – considers variants with threshold values of one and two percentage points. If triggered, the transfer amounts to the additional expenditures an average unemployment insurance scheme in the euro area would have to bear in the corresponding year. Dolls adds: “The analyzed re-insurance aims at striking a balance between providing stabilization on the one hand and preserving incentives on the other hand.”

The paper finds that the re-insurance would have absorbed on average 15-25 percent of the income losses originating from rising unemployment in deep recessions. This cushioning effect would have arisen through the interregional smoothing channel of the re-insurance scheme which is economically as important as the intertemporal smoothing effect of an average domestic unemployment insurance scheme in the euro area.

In particular, member states with deteriorating labour market conditions in the aftermath of the financial and economic crisis of 2008/09 such as Ireland, Latvia or Spain would have been supported. In the variant with a threshold value in the activation rule of one percentage point, also countries like Austria, Finland, France or Germany would have received transfers from the re-insurance.

Over the whole simulation period, some member states would have been in a net contributor, others in a net recipient position vis-a-vis the re-insurance. The rules triggering contribution and transfer payments would have ensured that no member state turns out as a permanent net contributor or net recipient.

Dolls concludes: “An unemployment re-insurance scheme should be viewed as a potential element of a balanced and more comprehensive reform package for the euro area that contributes to enhanced

market discipline, risk reduction and risk sharing. In practice, a re-insurance scheme would need to be designed such that negative incentive effects are minimized as far as possible. For example, contribution payments would need to be experience-rated and conditions should be attached to the availability of the re-insurance, in particular compliance with fiscal rules.”

See the full paper: EconPol Policy Report 10