Sunday, October 15, 2006

Efficiency vs. Equity: Maine and NB

As reported in The Globe and Mail last week, and addressed by Greg Mankiw earlier, two economists have published a paper that compares the extraordinary employment gap between Maine and New Brunswick.
If you provide very generous unemployment insurance, you may end up with more long-term unemployment. That's what economists Peter Kuhn and Chris Riddell find when they compare the long-term impact of a highly generous unemployment insurance (UI) program in the Canadian province of New Brunswick with the more modest UI program in the neighboring state of Maine. In Maine's northernmost countries, about 6.1 percent of employed men worked fewer than 26 weeks (half a year) in 1990. Across the Saint Croix River in New Brunswick, the comparative figure was more than three times as high, 20.8 percent. The more-generous UI program in New Brunswick accounts for about two-thirds of this difference, the authors estimate.
The central message from this study is difficult to argue with: the design of a UI program has a major affect on disincentives to work. It's easy enough to question whether Riddell and Kuhn held all the right factors constant (political and social institutions, taxing policies, nature of industries etc etc). I won't address these here. Further, for the most part, many such concerns seem to be unimportant to the undeniably strong central message.

I have just two comments.

The first is in response to the comments expressed on Greg Mankiw's blog. Several people forwarded the opinion that there is a trade off between equity and efficiency. This annoys me.
A well-designed UI program that promotes efficiency and productivity is promoting equity. Equity has many definitions, but my favorite is this: “a career of hard and responsible work should earn a higher pension than one of slacking or routine casual work.” Thus, equity, according to my favorite definition, encourages efficiency if we assume that individuals are rational and would prefer to earn a higher wage.
In relation to Riddell and Kuhn's findings, I would argue that even a well-designed UI program is destined to produce a poor efficiency and equity outcome in an economically challenged region like N.B. If we accept Okun's Law, it takes 2.5% points of growth above the trend growth rate (which, in N.B., averages 2.25 per cent in the annual real rate over the past five years up to 2005) to lower unemployment by one per cent. With this in mind, efficiency and equity without the promotion of migration is a high goal to set. I don't see how 35,000 unemployed in a labour force of 385,000 in an inviable province signals otherwise. Can equity be achieved in New Brunswick? Well, not through endless ill-efficient subsidization. In sum, the efficiency-equity tradeoff has little grounds.
My second point is this: to what extent does path dependency have an affect on the figures that Riddell and Kuhn arrive at? To explore path dependency, consider the ways that the unproductiveness of the New Brunswick labour force is self-perpetuating. For example, in the time period that members of the New Brunswick labour force are unemployed, their unproductiveness is increasing. Further, the attractiveness of New Brunswick to businesses seeking to establish themselves is decreasing. What is the effect? If such historic trends matter, it must be the case that the 2.5 percentage points of growth necessary (above a declining trend growth rate to put a damper on unemployment by one percentage) is facing upward pressure. How can this not be the case when employment is drastically subsidized, the labour force is decreasing, and the ratio of unemployed to employed is increasing?
A third and a fourth point have popped into mind, but I'll exercise will power and pursue something more productive. This is such a rich subject that I could rant on it forever (at the full risk of contributing nothing new, I might add).


happyjuggler0 said...

Perhaps the most efficient, and most "equitable" government intervention would be to send those who are unemployed with dim employment prospects due to local conditions, to Alberta.

Too much unemployment in one location, with a labor shortage in the other. If one factors in government tax revenue received from the newly employed, along with newly additional output from their new employers (and resulting taxes), as well as reduced government handouts due to ending someone's unemployment problem, this might result in a "profit" for the government, as well as the individual, as well as the new employer.

true dough said...

Yes, happyjuggler0! That's such a wise blueprint. This plan would also make it more feasible to provide the citizens with affordable and higher quality services like health care. And the government would turn a “profit?” Surely!

But I can't think of an incentive that would be strong enough. The problem is that the least educated residents with the lowest current prospects are the exact people with the lowest propensity to migrate (even though their very least prospect in Alberta is to work for $20/hr at McDonald's). It seems hard to believe that they have a reservation wage, high or low. Therefore, what is the incentive? Maybe they simply have strong ties to their land.

I expect that in the long run we'll see a hollowing out of unproductive regions, but I can't think of an incentive strong enough to ease the transition.

BSF said...

What do you think of Phelps' proposal to subsidise firms which hire low-wage workers?

true dough said...

Thanks for bringing my attention back to Phelps' work. It probably won't surprise you to learn that I'm still not sold. But I'm not entirely ready to dismiss the idea. Here are my qualifiers. First, surely the strength of his idea rests in the empirical work (I'll give him the benefit of the doubt since he's the one with the Nobel Prize). Second, I haven't read nearly as much as I'd like to on this.

Phelps says: “...the pay of less qualified workers is so meager that, if their situation is not dire, they find it emotionally difficult to keep a job for long, or they become to demoralized or distracted to be adequate employees, or minimum-wage laws make them unaffordable to law-abiding employers.”

Any unemployed Albertan who refuses to put on a McDonalds cap will speak otherwise. The wages aren't demoralizing, flipping burgers is.

On the other hand, it's possible that the empirical work could make my above point irrelevant. I can think of an example that makes Phelps' proposal easier to swallow. It's not quite what Phelps has in mind, but it helps get my point across.

Firms like Tyson Foods are already being subsidized by the Alberta government to draw short term employees from overseas, yet no level of government is willing to offer subsidization to firms that draw employees from economically weak regions within Canada (with few exceptions for special groups), despite Alberta's labour shortage. In other words, an incentive that is high enough to attract an opportunistic Filipino (who likely has more to gain) is not high enough to attract a certain type of unemployed Canadian with a low propensity to move. In this example, there's still more to the equation than Phelps' theory on meager pay, but now it's irrelevant. Jobs are getting filled because of government subsidies.

Phelps must have reason to believe that the benefits outweigh the risk of overshooting/undershooting an optimal wage.

I do hope you'll share your take.

true dough said...

I should have referenced my quote from Phelps:

via Mark Thoma