1. Does a reduction in benefit payment duration increase employment? Evidence from the German “Hartz Reforms” ISEO Summer School 2012 Felix König - London School of Economics 1

2. Content 1.The unemployment crisis 2.The German labour market and reform 3.A simple search model 4.The effect of the labour market reform 2

3. The unemployment crisis CrisisGerman labour marketModelReform resultsInequality 3

4. Unemployment duration as % of the total labour force OECD Employment Outlook 2011 Rising long-term unemployment, even in flexible labour markets CrisisGerman labour marketModelReform resultsInequality 4

5. Unemployment during the crisis OECD Employment Outlook 2011 CrisisGerman labour marketModelReform resultsInequality 5

6. Questions of this presentation 1.What is the reason for the German success? 1.What can be done to tackle high unemployment rates? 2.Is Merkel’s labour market reform agenda for Europe non-sense? CrisisGerman labour marketModelReform resultsInequality 6

7. The German labour market 7

8. “Sick man of Europe” German unemployment rate OECD quarterly Data in % Peter Hartz CrisisGerman labour marketModelReform resultsInequality 8

9. The “Hartz Reforms“ Jan 2003 Reduced restriction and taxation of low paid work (mini-jobs) Facilitate temporary employment (“rent a worker“) Jan 2004 Reform of structure of job centres (centralises federal structure) Jan 2005 Introduction of a single subsistence allowance (ALG 2) Feb 2006 Reform of the payment duration of UI CrisisGerman labour marketModelReform resultsInequality 9

10. A job miracle? German unemployment rate OECD quarterly Data in % Falling unmployment since Q1 2006 Peter Hartz CrisisGerman labour marketModelReform resultsInequality 10

11. A job miracle? CrisisGerman labour marketModelReform resultsInequality 11

12. Does this mean Mrs. Merkel is right? CrisisGerman labour marketModelReform resultsInequality 12

13. Duration of unemployment benefit Three changes allow for identification CrisisGerman labour marketModelReform resultsInequality 13

14. A difference in difference framework Reasons for being in the treatment group: 1.Older than a comprable individual 1.More work experience than a comprable individual 1.Timing of work experience at an unfortunate point in time CrisisGerman labour marketModelReform resultsInequality 14

15. Difference in Difference assumptions before y it1 = c i +λ t + u it after y it+1 = c i + λ t+1 + α + u it+1 before y jt1 = c j + λ t +u jt after y jt+1 = c j + λ t+1 + u jt AffectedNon-affected ∆ y it+1 = λ t+1 – λ t + α + ∆ u it+1 ∆ y jt+1 = λ t+1 – λ t + ∆ u jt+1 Need common trend for identification CrisisGerman labour marketModelReform resultsInequality 15

16. Common trend assumption CrisisGerman labour marketModelReform resultsInequality 16

17. In a DID regression set up y it = θ t + X it 'β + δ After + γ Treated +μ(A*T) estimates -8.42.1 -1.7 White standard errors (0.7)(0.5) (0.7) Covariates: monthly time dummies, age dummies, education dummies, work experience dummies and a gender dummy Unemployment duration in months CrisisGerman labour marketModelReform resultsInequality 17

18. Effect of UI payment duration reform A one-week reduction in BPD leads to 1.32 days reduction in the unemployment duration The average unemployment spell length decreased by about 9 days This amounts to 37,5 % of the decline in spell duration in Germany since 2006 CrisisGerman labour marketModelReform resultsInequality 18

19. So cutting benefit payments is a success story? 19

20. Labour market flows Elsby, Smith, Wadsworth (2010) Change in unemployment not necessarily due to employment CrisisGerman labour marketModelReform resultsInequality 20

21. A simple search model Behaviour changes as benefit expiry approaches Objective function: (roughly following Mortensen 1977) FOCs evaluated in the initial period of unemployment (U = U T ) : 2. 1. c: search cost in units of consumption s: search intensity w R : reservation wage U: value func. of being unemployed b: benefits λ(s): rate of job offer arrivals ( λ’>0 & λ’’<0 )u: instantaneous utilityW: value func. of working s*: threshold of search activity, below it a person is considered inactive

22. Stylised time pattern of the exit rate TTime Exit rate Job finding rate Job finding + becoming inactive Exit rate from unemployment T Benefits expire CrisisGerman labour marketModelReform resultsInequality 22

23. Estimating the exit rate The hazard rate is the probability that an individual leaves unemployment in a given time interval (months in this case): CrisisGerman labour marketModelReform resultsInequality 23

24. Does this mean Mrs. Merkel is wrong? CrisisGerman labour marketModelReform resultsInequality 24

25. Conclusions about spell duration Unemployment duration was reduced by 1.7 months The time to find a new job fell by 1.3 months But only 17% of the unemployed affected Effect on the treated CrisisGerman labour marketModelReform resultsInequality 25 Unemployment duration -24 days Total change -7 days Matching efficiency Inactivity -2 days Residual -15 days Reform

26. Refrences Card, Chetty, & Weber. (2007). The Spike at Benefit Exhaustion. American Economic Review, 97 (2), 113-118. Mortensen. (1977). Unemployment Insurance and Labour Supply Decision. Industrial and Labor Relations Review, 30 (4), 505-517. OECD Employment Outlook 2011 Socio-Economic Panel (SOEP), data for years 1984-2009, version 26, SOEP, 2010 van-Ours, & Vodopivec. (2006). How shortening the Potential Duration of Unemployment Benefits Affects the Duration of Unemployment: Evidence from a Natrual Experiment. Journal of Labour Economics, 24 (2), 351-378. 26

27. Reply to questions: Question: Maybe the affectedgroup takes different jobs compared to the unaffected(e.g. due to training differences among age groups). The common trend assumption might therefore fail. Reply: 1. The responsiveness to shocks before 2006 can be tested directly. Such worries are unwarranted according to previous slides. 2. For differential shocks that only occur after 2006 can only do indirect testing. Consider Industries with greatest share of job creation for the two groups. Four of the top five job creation industries are identical. No other industry creates more than 5% of jobs. Hence differential developments across industries are unlikely to bias the results. 27