Working Paper: CEPR ID: DP5937
Authors: Nicola Pavoni; Giovanni L. Violante
Abstract: A Welfare-to-Work (WTW) program is a mix of government expenditures on various labor market policies targeted to the unemployed (e.g., unemployment insurance, job search monitoring, social assistance, wage subsidies). This paper provides a dynamic principal-agent framework suitable for analyzing chief features of an optimal WTW program such as the sequence and duration of the different policies, the dynamic pattern of payments along the unemployment spell, and the emergence of taxes/subsidies upon re-employment. The optimal program endogenously generates an absorbing policy of last resort ('social assistance') characterized by a constant lifetime payment and no active participation by the agent. Human capital depreciation is a necessary condition for policy transitions to be part of an optimal WTW program. The typical sequence of policies is quite simple: the program starts with standard unemployment insurance, then switches into monitored search and, finally, into social assistance. The optimal benefits are decreasing during unemployment insurance and constant during both job search monitoring and social assistance. Whereas taxes (subsidies) can be either increasing or decreasing with duration during unemployment insurance, they must decrease (increase) during a phase of job search monitoring. In a calibration exercise, we use our model to analyze quantitatively the features of the optimal program for the U.S. economy. With respect to the existing U.S. system, the optimal WTW scheme delivers sizeable welfare gains to unskilled workers because the incentives to search for a job can be retained even while delivering more insurance, and using costly monitoring less intensively.
Keywords: human capital; job search monitoring; recursive contracts; unemployment insurance; welfare-to-work
JEL Codes: D82; H21; J24; J64; J65
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| human capital depreciation (J24) | optimal WTW program transitions (C61) |
| optimal WTW program transitions (C61) | sequence of policies (D78) |
| faster human capital depreciation (J24) | quicker transitions between policies (O24) |
| optimal benefits during unemployment insurance (J65) | decrease over time (D15) |
| benefits during job search monitoring and social assistance (J68) | remain constant (C62) |
| optimal program (C61) | significant welfare gains to unskilled workers (F66) |