,

Optimal Welfare-to-Work Programs

Nicola Pavoni

(University College London, and IFS)

Gianluca Violante

(New York University, and CEPR)

Introduction

• _{Government expenditures on labor market policies across OECD}

countries amount to 3% of GDP:

◮ _{Examples of policies: unemployment insurance, social}

assistance, job-search monitoring, training, wage subsidies

Introduction

• _{Government expenditures on labor market policies across OECD}

countries amount to 3% of GDP:

◮ _{Examples of policies: unemployment insurance, social}

assistance, job-search monitoring, training, wage subsidies

• _{Most governments use a mix of policy instruments}

• _{A Welfare-to-Work (WTW) program is a government expenditure}

What do we do?

• _{We study WTW programs from a normative perspective}

• _{An optimal Welfare-to-Work (WTW) program is a program that}

maximizes the unemployed agent ex-ante utility, for a given level of government expenditures

• _{We want to characterize:}

◮ _{optimal sequence of policies}

◮ _{optimal level and time-path of unemployment benefits}

What do we do?

• _{We study WTW programs from a normative perspective}

• _{An optimal Welfare-to-Work (WTW) program is a program that}

maximizes the unemployed agent ex-ante utility, for a given level of government expenditures

• _{We want to characterize:}

◮ _{optimal sequence of policies}

◮ _{optimal level and time-path of unemployment benefits}

How do we do it?

• _{Dynamic principal-agent (government-worker) relationship with}

moral-hazard (unobservable worker effort), following Shavell and

Weiss (1979), Hopenhayn and Nicolini (1997)

• _{We generalize their set-up in two dimensions:}

1. introduce human capital dynamics

◮ _{wages and unemployment hazard depend on human capital}

2. develop a richer economic environment

Economic environment I

• _{Agent’s intra-period utility u(c) − a}

◮ _{Separable in consumption c and effort a}

◮ _{u(·) increasing, concave, smooth, and u}−1

has convex first derivative (Newman, 1995)

• _{Agent’s effort a ∈ {0, e}, i.e. two effort levels}

• _{Workers endowed with human capital h ≥ 0, and the wage ω(h) is}

Economic environment II

• _{Agent can be either employed or unemployed}

• _{Employment is an absorbing state}

• _{During unemployment:}

◮ _{human capital depreciates: h}′ _{= (1 − δ)h}

◮ _{search with job-finding probability π(h, a), where}

π(h, e) > π(h,0) = 0, and π_h(h, e) > 0

Principal-Agent relationship

• _{Agent’s search effort a is private information}

◮ _{Monitoring technology: upon payment of per-period}

monitoring cost κ, principal can observe search effort a

• _{The risk-neutral principal offers a contract that specifies:}

◮ _{recommendations on the search effort level a}

◮ _{consumption for agent}

Options of the contract as policies of the WTW program

• _{Combination of recommendations on effort, and use of monitoring}

technology lead to 3 policy instruments:

◮ _{UI: Unemployment Insurance (high effort, no monitoring)}

◮ _{JM: Job-search Monitoring (high effort, monitoring)}

Options of the contract as policies of the WTW program

• _{Combination of recommendations on effort, and use of monitoring}

technology lead to 3 policy instruments:

◮ _{UI: Unemployment Insurance (high effort, no monitoring)}

◮ _{JM: Job-search Monitoring (high effort, monitoring)}

◮ _{SA: Social Assistance (low effort, no monitoring)}

Economic forces at work in the choice of policies

Economic forces at work in the choice of policies

• _{Returns to search (UI/JM vs SA): increasing in h}

Economic forces at work in the choice of policies

• _{Returns to search (UI/JM vs SA): increasing in h}

• _{Effort compensation cost (UI/JM vs SA): increasing in U}

• _{Incentive cost (UI vs JM)}

Us − Uf ≥ e

βπ(h) (IC)

◮ _{decreasing in h (for UI)}

◮ _{increasing in U: if u}−1

Characterization

• _{Proposition 1: SA is an absorbing policy, i.e. if it is chosen at any}

Characterization

• _{Proposition 1: SA is an absorbing policy, i.e. if it is chosen at any}

period t, choosing it thereafter is optimal

• _{Proposition 2: Human capital depreciation is necessary for policy}

transition within an optimal WTW program, i.e. in absence of

Characterization

• _{Proposition 1: SA is an absorbing policy, i.e. if it is chosen at any}

period t, choosing it thereafter is optimal

• _{Proposition 2: Human capital depreciation is necessary for policy}

transition within an optimal WTW program, i.e. in absence of

human capital depreciation, every policy is absorbing.

• _{Proposition 3: With human capital depreciation, the optimal}

Quantitative analysis

• _{Calibration of the model to U.S. labor market}

• _{Compute optimal WTW program for the same level of expected}

utility U0 promised by the current program

Quantitative analysis

• _{Calibration of the model to U.S. labor market}

• _{Compute optimal WTW program for the same level of expected}

utility U0 promised by the current program

◮ _{Simulate current program to compute U0}

• _{Question I: How different are the features of the optimal program}

Quantitative analysis

• _{Calibration of the model to U.S. labor market}

• _{Compute optimal WTW program for the same level of expected}

utility U0 promised by the current program

◮ _{Simulate current program to compute U0}

• _{Question I: How different are the features of the optimal program}

compared to the current one?

• _{Question II: How big is the budget saving for the government from}

Calibration I: U.S. labor market

• _{Period: one month}

• _{Focus on individuals aged 18-50, ≤ HS degree}

• _{Preferences: log(c) − a}

• _{Skill depreciation rate: 15% per year}

Calibration II: U.S. WTW system

Calibration II: U.S. WTW system

• _{Phase I: 6 months of UI, with 60% replacement ratio}

• _{Phase II: Up to 24 months of Temporary Assistance for Needy}

Families ($740 per month) with enrollment into JM program:

Calibration II: U.S. WTW system

• _{Phase I: 6 months of UI, with 60% replacement ratio}

• _{Phase II: Up to 24 months of Temporary Assistance for Needy}

Families ($740 per month) with enrollment into JM program:

◮ _{κ = $478 per worker-per month}

• _{Phase III: policies of social assistance (SA)}

Calibration II: U.S. WTW system

• _{Phase I: 6 months of UI, with 60% replacement ratio}

• _{Phase II: Up to 24 months of Temporary Assistance for Needy}

Families ($740 per month) with enrollment into JM program:

◮ _{κ = $478 per worker-per month}

• _{Phase III: policies of social assistance (SA)}

◮ _{Food Stamps, with indefinite duration ($290 per month)}

10 20 30 40 50 60 0 0.2 0.4 0.6 0.8 1 Months

Fraction of workers in each program

Program assignment

10 20 30 40 50 60 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 Months

Fraction of initial wage

Payments (replacement ratio)

10 20 30 40 50 60 0.05 0.1 0.15 0.2 0.25 0.3 0.35 Months

Fraction of current wage

Subsidy upon re−employment

0.4 0.6 0.8

1 Program assignment

0.5 0.6 0.7 0.8 0.9 1

Payments (replacement ratio)

0.15 0.2 0.25 0.3 0.35