What Economic Theory Has to Say About Unemployment

The weakness of the economy is not a structural weakness, it is not that we are over inflating blue chip stocks, or shoveling weak mortgages. It is that we are at war with an enemy we cannot see.

By Jacob Carrasco

The Republican party has the economics all wrong. Congress and the president have been blockading further federal benefits to the unemployed based on the fallacy that because people are making more on Unemployment Insurance (UI) than they did while employed, they will choose to remain unemployed. Economic theory flatly refutes that fallacy. The danger of this popular notion is that if people who are unemployed don’t get the financial support they need, there will be dire consequences across the economy.

In economic theory, we generally assume that people make smart decisions and make decisions that not only affect today, but also tomorrow. With regards to income, these decisions resemble theory from finance, where a discounted cash flow is the metric by which people in the economy choose whether to work, or not to work, take a new job, or keep the same one. How this manifests in real life is that people count today’s income as the most important, as $1,000 today is worth a little more than $1,000 tomorrow. This logic continues where cash received in 2 weeks is valued higher than cash received in 4 months, and is valued higher than cash received in 4 years. The sum of these expected cash flows, discounted to a preferable present cash value is the number used to consider whether or not we are getting a good deal or not.

Now consider the unemployed person: currently with the $600 weekly benefit, there is a chunk of those unemployed who have more cash being put into their pocket every week than they did when they worked full time at their job. This is especially true for the low-wage workers that are some of the hardest hit by the COVID-19 shutdown.

What these rational agents consider when making the choice between staying unemployed or returning to work is the present value of benefits at the start of each new week. In the first week, economic theory would posit that surely the unemployed might like to stay unemployed because at that moment the present value, the cash value today, of their unemployment benefits is higher than that of a low wage job.

The catch is that unemployment in normal times doesn’t last more than half a year, or 26 weeks. Thanks to the CARES act, the maximum amount of unemployment allotted is pushed up to 39 weeks, or 3 quarters of a year. After those 39 weeks, if you are still unemployed, the benefits end and you will cease to get a single penny. Whereas with a job, barring any unforeseen circumstances, the promise of cash flow is much longer on the scale of years, or even decades.

The concept that unemployment benefits are temporary is shown in the graph above produced by myself. The blue line represents the present value of unemployment benefits at the beginning of each week, time zero representing the initial receipt of benefits and time 2 representing the second week of benefits. We can see that at first the blue line far surpasses the orange line which shows the present value of wages– a value which does not change because it is a perpetual, constant cash flow. There comes a point though wherein the blue line dips below the orange line, and at that point it is preferable to get a job as soon as possible because soon your benefits will run out and you will be left with no income. The intersection point occurs at around 26 weeks assuming that unemployment benefits last 39 weeks, meaning that around mid-September we would expect the unemployed to seriously look for work as they see the cliff of income coming dry.

This intersection brings us the central dilemma of unemployment – that there is a switch off point. There is a point where despite receiving more in cash flow per week from unemployment, that a worker would decide to go back to work early if given the chance. This is because they can see the end to unemployment, and are now factoring zero cash flows past 39 weeks into their decisions.

This is why the fallacy of the unemployed worker choosing to stay unemployed is more likely to be based on a distinct distaste and ignorance of the circumstances of the poor than a serious consideration of economic theory. It is true that the NPV of unemployment benefits is higher than working in the first few weeks, but the time will come when working is preferred.

Some critics may argue that we should always be incentivizing work and that nobody should want to stay unemployed. This hard-nosed ethic flies in the face of the current reality that going back to work is not possible or desirable for reasons beyond the monetary for many. Currently we are still in the midst of a shutdown wherein even if the 30 million unemployed americans all wanted jobs, there would only be 5 million jobs to go around. There are many businesses who would have jobs, but who would also be putting their employees and their families at direct risk of infection if they were to return to work– think your bartenders, movie theater employees, waiters, musicians. This risk of infection is bad for everyone. It can be seen that beyond the monetary there is a tension to return to work as the risk of being infected or infecting someone else is too high a price to compete with staying at home. We as a country shouldn’t be forcing people to choose between paying their bills and possibly dying or infecting others. This tension will only become more pronounced as time goes on and eventually all benefits end in December.

To avoid an even graver recession, we must continue to fill the gap for unemployed workers until this pandemic is under control and people can return to work safely. We must ensure that people have enough to pay their bills, or else the pain inflicted on the poor might trickle up into a bigger problem for everyone.

The GOP has debated taking benefits completely off the table, or reducing the supplement to $200 a week. This would have disastrous effects on the already strained economy. Consumption is by far the largest contributor to the GDP and if people are forced to cut back and buy less groceries, buy less clothing, buy less school supplies, skip rent payments, skip mortgage payments, buy less gas – then the buck is going to come screeching to a halt. People with little to no previous savings will be forced to cut consumption, which will cut revenues for companies that cannot move as much product. If companies cannot sell products they will be laden with unsold inventory which will increase the debt burden on an already debt-laden corporate sector, and you can see then how the scrapes turn into cuts.

In all of this one must truly understand that the weakness of the economy is not a structural weakness, it is not that we are over inflating blue chip stocks, or shoveling weak mortgages, it is that we are at war with an enemy we cannot see. That had there been no coronavirus, there would have been no weakness in the economy. That if we had competent leadership to take a stand for science and the lives of almost 150,000 Americans, we might not have had such a long brutal shutdown. That we might not have had an explosion in cases when the rest of the world is on the downturn. The extent of the calamity of the coronavirus in the United States was wholly avoidable, and the reason we are paying people to stay at home is in the hopes that if we play our cards right, we won’t shoot an otherwise healthy economy in the foot. The true enemy is ignorance and an inability to act, not someone wondering if they will ever get their job back and whether or not they truly need electricity after their benefits get cut. □

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