What do benefits have to do with wage scarring?
I’m presenting to my colleagues about wage scarring today - and they are all sharp like a fresh samuri sword, so I’ve decided I should spend my blogging time preparing. Specifically, I’m keen to focus on an element of the motivation for why we’d even research wage scarring - understanding the link between the benefit system and future earnings outcomes.
Note: It’ll be a few months until I share any of the work here - so it can go through the roadshow ringer first. But if you want to see the type of estimates that have been pulled together for Australia by my colleagues and I at e61 take a look at this, this, and this and this write up as well as this one.
A couple of years ago New Zealand talked about a potential income insurance scheme as a reform to the benefit system. This is a policy debate that is relevant on both sides of the Tasman given how unique the flat rate non-contributory system of Australiasia is to other countries.
When we see ourselves doing something differently than everyone else it is worth asking - is our approach best, or can we learn something from overseas?
New Zealand’s motivation
Facing the sudden loss of a job is a fairly substantive life shock. So as a society everyone tends to believe in sharing the burden of this in some way.
But why do we think giving people compulsory income insurance - rather than just providing a safety net - is beneficial? Specifically, why would we create a system that gave more to those with higher prior earnings (with related contributions from individuals with higher earnings during their life)?
Individuals are unable to self-insure - meaning that they have to excessively cut back on spending after job loss, and have to “save/spend on insurance” more when working.
Individuals with higher income have higher fixed expenses, making a flat payment less effective at supporting them through a transition.
Individuals suffer a wage penalty (a wage scar) in future work solely due to job loss - this could be due to dropping off the career ladder, losing human capital/firm specific skills, or losing work they were well matched to.
These arguments aren’t really separate, but it is useful to split them into different categories to think about what we need to measure. In this way the final argument - that there is a larger wage loss due to job loss given this missing insurance market - was a key motivation for the policy.
Now I don’t know what “bigger” means here - as we’ve noted wage scarring in NZ and Aussie doesn’t really seem bigger than in other countries.
But why would such “income insurance” influence how much of a future wage penalty people would face?
Search and wage scarring
So what is the key link between benefit policies and these wage penalities? It is the idea of job search and job match quality.
The traditional literature on benefit policy focuses on consumption smoothing - with the Bailey-Chetty result giving us a way to think about the benefit rate that trades off between allowing people to maintain consumption and the moral hazard cost of them deciding to extend their time out of work due to the payment.
The idea that the structure of benefits might influence future earnings has not been ignored - but instead the aggregate effect of these things is quite small (i.e. Schmieder, von Watcher, and Bender 2016).
A more generous benefit payment is expected to make people spend longer searching. This may mean:
They only agree to a “really good match” - meaning that people don’t get stuck in bad jobs.
They delay making a match and progressively lose human capital and skills.
Logically the impact is unclear - and people with a given set of beliefs then only focus on one part.
However, the international result of “not important” is contingent on the institutional and policy structure in the place where it occurs. And Australia/New Zealand are pretty different to Germany.
Hence, knowing how much wage scarring actually occurs - and what influence the structure of benefit payments and employment services have on the quality of job matches is pretty important information for considering future reform.
So seeing a picture like this - from our public work on wage scarring from the GFC - is really only the first step in what we want to try to understand for future policy making. Our goal is to understand a bit more about why this is occurring and for who - and ultimately the role played by different institutional or policy factors
If you have some good answers feel free to share them below ;)