Juan Vasquez- Unemployment Insurance

In October 2009 15.1 million Americans were out of work, the unemployment rate had reached 9.8%, a level not seen since mid-1983. Events such as this are completely unpredictable and very costly. During unemployment spells, consumption tends to drop significantly due to the lost of income. Although these adverse events are difficult to predict, an economically conscious person will be prepared to face them through saving earned income. The fact of the matter is that the majority of people are not very economically conscious of their well being for the future. For this reason, the government takes it upon itself to protect those, who do not save money, from entering in to poverty as a result of an adverse event, such as unemployment. State governments provide unemployment insurance, for those eligible, to help smooth consumption across the negative and positive states of the world. It is crucial for the government to play a role in administrating social insurance because of the major asymmetrical information that causes heavy adverse selection within the private insurance market. With that said, too much government aid causes a moral hazard that counters the original goals of insurance; for this reason, I believe the government’s role in the social insurance market should exist, but very limited, and there should be an encouragement to incentivize those who do not save to start doing so for their own good.

First, individuals value insurance because they would ideally like to smooth their consumption across states of the world. Second, there are a number of reasons why the market may fail to provide such insurance, most notably adverse selection. Third, even if the market fails to provide such insurance, the justification for social insurance depends on whether other private consumption-smoothing mechanisms are available. Fourth, expanding insurance coverage has a moral hazard cost in terms of encouraging adverse behavior. These lessons have a clear policy implication: optimal social insurance systems should partially, but not completely, insure individuals against adverse events. The benefit of social insurance is the amount of consumption smoothing provided by social insurance programs. The cost of social insurance is the moral hazard caused by insuring against adverse events. As a result, social product becomes inefficient and the government must raise taxes to account for the excess, which lowers social efficiency. Thus, higher social insurance improves social efficiency by fixing a market failure but reduces social efficiency by reducing production and raising taxes. The resolution of this full insurance/adverse behavior trade-off will generally be somewhere in the middle, optimally providing some insurance against adverse events, but not full insurance. As of now, I believe too much unemployment insurance is offered, which is why increasing unemployment spells are so common. With that said, I do believe the government should intervene, but only when absolutely necessary. With a system like the UISA, the government does not intervene unless it is absolutely needed. This program also encourages private saving and discourages the moral hazards that come with the excess government funding.