NCPA - National Center for Policy Analysis


November 18, 2009

Why did the unemployment rate rise so rapidly -- from 7.2 per cent in January to 10.2 percent in October?  It was clearly the administration's "stimulus" bill -- which in February provided $40 billion to greatly extend jobless benefits at no cost to the states, says Alan Reynolds, a senior fellow with the Cato Institute.

As Larry Summers, the president's top assistant for economic policy, noted in July, "the unemployment rate over the recession has risen about 1 to 1.5 percentage points more than would normally be attributable to the contraction in gross domestic product."  And the rate has moved nearly a percentage point higher since then, even though the gross domestic product increased.  Countries with much deeper declines in GDP, such as Germany and Sweden, have unemployment rates far below ours.

Summers knows why the U.S. rate is so high.  He explained it well in a 1995 paper co-authored with James Poterba of the Massachusetts Institute of Technology (MIT): "Unemployment insurance lengthens unemployment spells."  For instance:

  • When the government pays people 50 to 60 percent of their previous wage to stay home for a year or more, many of them do just that.
  • And the stimulus bribed states to extend benefits -- which have now been stretched to an unprecedented 79 weeks in 28 states and to 46 to 72 weeks in the rest.
  • Before mid-2008, by contrast, only a few states paid jobless benefits for even a month beyond the standard 26 weeks.

When you subsidize something, you get more of it, explains Reynolds.  Extending unemployment benefits from 26 to 79 weeks was guaranteed to leave many more people unemployed for many more months.

And longer unemployment translates to higher unemployment rates -- because the relatively small numbers of newly unemployed are added to stubbornly large numbers of those who lost their jobs more than six months ago.

Until benefits are about to run out, many of the long-term unemployed are in no rush to make serious efforts to find another job -- or to accept job offers that may involve a long commute, relocation or disappointing salary and benefits, says Reynolds.

Source: Alan Reynolds, "The 'stimulus' for unemployment," New York Post, November 17, 2009.

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