The Case Against Wage Insurance

 At the CEA meetings I participated on a panel organized by IRPP to discuss a recent paper  – by Finnie and Gray – on older laid-off workers and the policy option of “wage insurance.”

 The paper shows that older laid off workers leaving stable jobs and finding new employment typically experience significant declines in earnings – in the range of one quarter to one third for those in their 50s. Many drop out of the work force: 1 in 4 of those aged 45 to 59 leave the work force within 5 years.

Finnie and Gray argue that current active EI programs such as skills training have a poor track record, and they propose an experiment with wage insurance funded from EI. This would provide a temporary – perhaps two year – wage supplement to older laid-off workers who took a job but experienced a significant decline in earnings. They argue that such workers should also get job search assistance to encourage early job acceptance.

(The recent Task Force on Older Workers also suggested that consideration be given to a wage insurance program under EI.)

 The proposal is put forward in a nuanced and balanced way, albeit with rather little detail on program design, emphasizing the equity case for cushioning workers against large economic losses.

I am skeptical for several reasons. 

Wage insurance would provide a temporary subsidy from EI for workers taking a new job at lower pay. Several economists cited in the paper who have advocated such an approach depart from the neo classical assumption that significant numbers of workers, especially older workers,  have extended claim periods due to “sticky” wage expectations. Based on previous employment experience, they have a high “reservation wage.”  This can be lowered by topping up wages provided by a low wage job.   

However, there is a literature that looks at this issue quire differently, arguing that a significant period of adequate income support from unemployment insurance is needed to facilitate efficient job matching which enhances overall economic efficiency. What some see as an overly high “reservation wage” may reflect a legitimate expectation that a more focused job search will be successful, even if it takes time. From this point of view, wage insurance might induce a worker to take a low wage job much too quickly from the point of view of optimal matching in the job market.

The OECD (Employment Outlook 2007, Chapter 2) has looked at the impacts of unemployment insurance on productivity and concluded that “reforms that reduce the generosity of unemployment benefits are likely to reduce the aggregate level of measured productivity.” (p.57) They argue that more generous benefit systems allow unemployed workers the time and resources to find a new job which better matches their skills and experience, resulting in a better matching of the unemployed and available job vacancies.

In short, encouraging workers to take the first available low wage job rather than engage in a longer job search is sub optimal. 

Finnie and Gray’s argument for wage insurance also depends on their view that training interventions are expensive and have low rates of return, especially programs for older workers. They present evaluation reports of EI skills training programs in a rather pessimistic light.  However, subjective evaluations of skills development programs by participants have been much more positive, with the Ontario evaluation study showing that about 70% of participants felt that training was important to finding and holding a new job.

Some older workers are likely to prefer skills training which would help them find a better job rather than wage insurance which steers them to a low skill, low wage job. While successful training interventions may be relatively expensive due to the limited literacy and numeracy skills of some older workers, it would be unfortunate if the already very limited skills training programs available under EI were to be cut to fund a wage insurance program.  This is especially the case today given that the economics of public investment in training are shifting as skills shortages increase due to the pending retirement of many skilled trades and health care workers.

The main argument for wage insurance put forward by Finnie and Gray is based on equity, the intent being to cushion older workers from the impact of involuntary job loss. However, there could well be inequitable impacts on young workers.

In the most recent period of recession and recovery, the biggest negative impact has been on young workers. The employment rate of young workers has fallen sharply, while it has actually increased for workers age 55 and over. Long term unemployment is still experienced disproportionately by older workers, but it has increased sharply among all age groups.

It would seem that  displaced older workers have taken entry level, lower paid jobs, not moved into retirement earlier. In this context, wage insurance could just encourage even more substitution of  older for younger workers, including in part-time jobs which would be eligible for a wage subsidy.

Finnie and Gray’s proposal lacks a lot of detail, but it is problematic that it would be funded out of EI at a time when the “new” EI Fund is in deficit to the tune of more than $10 Billion. In this context, a wage insurance program would likely be funded by cuts to benefits or to EI funded training programs.

One detail of their proposal is objectionable. To be eligible for wage insurance, an older workers would have to have been stably employed, defined as having had no more than one EI claim in the previous four years. A similar stipulation in the recently expired program to provide extended EI benefits to some so-called long tenure workers in the recession had the effect of shutting out many industrial workers who had been previously laid-off due to the manufacturing jobs crisis (which began well before the Great Recession) or due to the simple reality that many plants lay off workers periodically for retooling.

Workers are now inelgible to collect EI unless they are involuntarily unemployed, so exclusion based on previous claims is unfair.

So, I am skeptical about the desirability of wage insurance. Better to improve EI benefits and EI training programs for all workers, and to expand programs like the Working Income Tax Benefit which provide direct income assistance to low paid workers.